Solution Manual for Auditing A Risk Based Approach to Conducting

a Quality Audit 9th Edition Johnstone Gramling Rittenberg

1133939155 9781133939153
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Chapter 14: Activities Required in Completing a Quality Audit

Student: ___________________________________________________________________________

1. Review activities that are completed towards the end of the audit are quite varied.
True False

2. Misstatements that are detected, but individually are not material, should be ignored when determining the
appropriate audit report.
True False

3. Most audit firms use a schedule to accumulate the known and projected misstatements and the carryover
effects of prior-year uncorrected misstatements.
True False

4. At the end of an audit, adjustments that are “waived” will remain uncorrected.
True False

5. The auditor compares the total likely misstatements to each significant segment of the financial statements,
such as total current assets, total noncurrent assets, total current liabilities, total noncurrent liabilities, owners’
equity, and pretax income, to determine if they are, in aggregate, material to the financial statements.
True False
6. The total likely misstatements found during the audit are equal to the sum of known and projected
misstatements.
True False

7. The materiality of a misstatement is based on only the quantitative amount of the misstatement.
True False

8. An audit firm culture that emphasizes “doing the right thing,” encourages auditors to deal with difficult issues
in a short period of time.
True False

9. A culture that encourages auditors to seek consultation with other members of the audit firm will be more
likely to result in auditors who will acquiesce to inappropriate or aggressive client preferences.
True False

10. PCAOB AS 14 provides important insight that auditors must consider as they decide whether management’s
refusal to correct a detected misstatement is indicative of intentional bias.
True False

11. In an integrated audit, if one or more material weaknesses exist, the auditor will need to issue a qualified
opinion on internal control over financial reporting.
True False

12. Multiple internal control deficiencies in the same cycle may actually decrease the likelihood of misstatement
in that cycle.
True False

13. FASB has set forth four categories of potential losses that can be reasonably estimated.
True False

14. Auditors are responsible for designing and maintaining policies and procedures to identify, evaluate, and
account for contingencies.
True False
15. The primary sourceof evidence concerning contingencies is the client’s external attorney.
True False

16. Regarding loss contingencies, legal counsel should be instructed by the client to respond directly to the
auditors.
True False

17. If a lawyer refuses to furnish the requested information about the client’s contingencies to the auditor, the
auditor should issue an unqualified audit opinion.
True False

18. Property and casualty insurance premiums are examples of estimates found on financial statements.
True False

19. Auditors should have heightened skepticism regarding period-end adjusting journal entries that relate to
accounts with significant estimates.
True False

20. Estimates are based on both subjective and objective factors.

True False

21. Events or transactions occurring after the balance sheet date and before the audit report date, can be useful
in identifying and evaluating the reasonableness of estimates.
True False

22. A deviation from historical patterns is one of the factors that an auditor focuses on when evaluating the
reasonableness of an estimate.
True False

23. The auditor should consider the historical experience of the client in making past estimates.
True False
24. A policy providing a reserve for returned products at the original sales price rather than at replacement cost
violates GAAP.
True False

25. If the auditor determines that informative disclosures are not reasonably adequate, the auditor must identify
that fact in the auditor’s report.
True False

26. Disclosures can be made either on the face of the financial statements in the form of classifications or in
parenthetical notations and/or in the notes to the statements.
True False

27. A disclosure checklist is a convenient documentation format for evidence that the auditor adequately
evaluated the client’s disclosures.
True False

28. The auditor should consider matters for disclosure only while gathering evidence during the course of the
audit.
True False

29. The auditor’s report specifically covers the statements and disclosures made by management in the
“Management Discussion and Analysis” (MD&A) section of the annual report.
True False

30. Auditors routinely review the MD&A to provide reasonable assurance that it does not contain information
that is factually inaccurate or inconsistent with the audited portion of the financial statements and
accompanying footnotes.
True False

31. Noncompliancewith laws and regulations includes only acts of omission by the entity that are considered to
be unintentional and contrary to the prevailing laws or regulations.
True False
32. Auditing standards recognize that there are inherent limitations in an auditor’s ability to detect material
misstatements relating to the entity’s compliance with laws and regulations.
True False

33. Auditors are responsible for obtaining reasonable assurance that the financial statements are free from
material misstatements, including material misstatements related to noncompliance with laws and regulations.
True False

34. When obtaining reasonable assurance that the financial statements are free from material misstatements,
auditors should consider the applicable legal and regulatory frameworks that apply to the entity.
True False

35. If management or those charged with governance do not demonstrate a commitment to internal control over
noncompliance with laws and regulations, then the auditor should withdraw from the engagement.
True False

36. According to the Foreign Corrupt Practices Act of 1977 (FCPA), companies that have securities listed on
U.S. markets must make and keep financial records that accurately and fairly reflect the transactions of the
company and design and maintain an adequate system of internal accounting controls.
True False

37. If an auditor becomes aware of violations of the Foreign Corrupt Practices Act of 1977 (FCPA), the auditor
should notify the CFO about the violations, their circumstance, and the effect on the financial statements.
True False

38. If a client makes payments to a middle-man who uses the funds to obtain corporate tax refunds for the client
from government officials, this is not considered a violation of the Foreign Corrupt Practices Act of 1977
(FCPA).
True False

39. Auditors are required to evaluate the likelihood of each client continuing as a going concern for a reasonable
period into the foreseeable future.
True False
40. If the auditor continues to have substantial doubt about the client continuing as a going concern, the auditor
should evaluate the adequacy of the client’s related disclosures.
True False

41. An audit opinion is a guarantee that the business is a going concern.

True False

42. The going-concern evaluation must be based on separate procedures that test the client’s ability to continue
as a going concern.
True False

43. Two paragraphs should be added to the auditor’s report when the auditor concludes that substantial doubt
remains about the client’s ability to continue as a going concern for a reasonable period of time.
True False

44. Management will often resist a going-concern modification because investors, lenders, and customers may
lose faith in the business.
True False

45. Some auditors may be reluctant to issue a going-concern audit opinion because it may hasten the failure of
the client company.
True False

46. Significant changes in the competitive market and a decrease in the competitiveness of the client’s products
are potential indicators of going-concern problems.
True False

47. A number of studies of bankruptcies have shown that certain combinations of ratios, like the Altman Z-
score, have good predictive power in indicating the likelihood of bankruptcy.
True False
48. Research has shown that auditors’ qualifications of audit reports are better predictors of going-concern
problems than are Z-score models.
True False

49. Analytical procedures help auditors assess the overall presentation of the financial statements.
True False

50. By performing a final analytical review, the audit firm will identify any unusual, unexpected, or unexplained
relationships that should be resolved before the issuance of the audit report.
True False

51. Analytical procedures may indicate that new controls need to be designed before completing the audit.
True False

52. Ratio analysis, common-size analysis, and analysis of the dollar and percentage changes in each income
statement item over the previous year are useful for this purpose.
True False

53. Analytical procedures conducted during the final review phase of the audit should corroborate conclusions
formed during the audit, which enables the auditor to draw conclusions upon which to base the audit opinion.
True False

54. When management is unable to provide an explanation for a previously unrecognized risk identified through
the analytical procedures, the auditor must issue an adverse opinion.
True False

55. The auditor should apply a basic three-step process for using analytical procedures during the final review.
True False

56. The auditor’s expectations in final analytical procedures must be more precise than those for substantive
analytics.
True False
57. The signing officers for the certifications under the Sarbanes-Oxley Act are typically the controller and the
treasurer of the company.
True False

58. In a quality audit, the auditor will review management’s processes for certification to provide reasonable
assurance that those processes are adequate and that they can be relied upon.
True False

59. Auditors should obtain a management representation letter at the end of each audit.
True False

60. Management’s refusal to sign the management representation letter is considered a scope limitation
sufficient to preclude the issuance of an unqualified opinion.
True False

61. Type I subsequent events indicate conditions that did not exist at the balance sheet date, but that may require
disclosure.
True False

62. An example of a Type I subsequent event would be a significant lawsuit that is initiated relating to an
incident that occurred after the balance sheet date.
True False

63. Procedures such as a cutoff test and a search for unrecorded liabilities are related to subsequent events.
True False

64. When the auditor becomes aware of an event that occurs after the audit report date, but before the issuance
of the audit report to the client and the event is disclosed in the footnotes, the auditor would date the report as if
this fact had been known at year-end.
True False
65. If the auditor decides that steps should be taken to prevent further reliance on the financial statements and
audit report due to subsequent events after issuance of the audit report, the auditor should not try to obtain client
cooperation, but should immediately notify any regulatory agency having jurisdiction over the client, such as
the SEC, that the audit report should no longer be associated with the client’s financial statements.
True False

66. An additional procedure related to subsequent events is the reading of the meeting minutes for the board of
directors meeting.
True False

67. If an omission of an important audit procedure is discovered, the auditor should immediately issue a
disclaimer of opinion for the audit.
True False

68. If omitted audit procedures cannot be performed, the auditor should extend previous work done and modify
the report, if necessary.
True False

69. Typically, omissions may be discovered when audit documentation is reviewed as part of an external or
internal review program.
True False

70. When it is discovered that an important audit procedure was not performed, the SEC imposes sanctions
against the audit firm responsible.
True False

71. As part of a quality audit, the audit firm must have policies and procedures in place for conducting an
engagement quality review of each audit before issuing the audit opinion for public companies.
True False

72. If an experienced reviewer who was not a part of the audit team, but who has appropriate competence,
independence, integrity, and objectivity, performs an independent quality review, this is referred to as a
reoccurring partner review.
True False
73. The engagement quality review is a risk-based review.
True False

74. The audit documentation when performing an engagement quality review should include such information
such as how much the firm paid for the review.
True False

75. It is important that the external auditor have a constructive and detailed dialogue with the audit committee
on important aspects of the audit.
True False

76. The audit committee is typically independent of the board of directors.

True False

77. All major accounting disagreements with management, even if eventually resolved, should be discussed
with the audit committee.
True False

78. The auditor generally reports things that management could do better in a management letteras a
constructive part of the audit.
True False

79. A management letter is the same as a management representation letter.

True False

80. A management letter is not required.

True False

81. After the auditor completes the current audit, an issue of importance for subsequent year audits is mandatory
partner rotation.
True False
82. Audit firm culture plays a role in audit firm portfolio management in that some audit firms are willing to
provide audits to riskier clients, while other audit firms are not willing to do so.
True False

83. In addition to risk factors, an important consideration in client continuance decisions involves the audit
firm’s growth strategy.
True False

84. Audit firm portfolio management decisions are not important in achieving audit quality.
True False

85. If an audit firm accepts or continues to provide audits to a client firm with ineffective internal controls over
financial reporting, the management representation letter will note that an adverse opinion will likely be issued.
True False

86. The familiarity threat is the most relevant issue for mandatory partner or audit firm rotation.
True False

87. Rules are standardized internationally in terms of mandatory partner rotation and mandatory audit firm
rotation.
True False

88. A cooling off period is the number of years after which the individual auditor or audit firm may resume its
prior role with the audit client.
True False

89. The AICPA Auditing Standards Board (ASB) requires a 5-year mandatory cooling off period for partner
rotation.
True False

90. The Public Company Accounting Oversight Board (PCAOB) requires mandatory audit firm rotation after
six years, with a cooling off period of four years.
True False
91. Most audit firms use a schedule to accumulate the known and projected misstatements and the carryover
effects of prior-year uncorrected misstatements. Which of the following statements regarding this process is
false?
A. Adjustments made to correct the financial statements are referred to as booked.
B. Possible adjustments to the financial statements that are left uncorrected are referred to as waived.
C. Tax effects are not shown on schedules of correcting errors.
D. The nature of the misstatement, as well as the quantitative amount, is considered in the judgment of
materiality.

92. During the course of an audit, misstatements that are individually immaterial may be detected. What should
the auditor do with these?
A. Permanently pass on these immaterial misstatements as they do not individually impact the financial
statements.
B. Request that management footnote the immaterial misstatements in the financial statements for fair
presentation.
C. Accumulate all of the known and projected misstatements to determine if the impact is material in the
aggregate.
D. Roll them forward for three years when they will become material enough to adjust.

93. Which of the following is one of the most important drivers of audit quality in cases where an auditor may
feel some pressure to acquiesce to management’s demands to not require that misstatements be corrected in
order to preserve a harmonious working relationship?
A. Firm culture.
B. Ethics training.
C. Annual income of the CPA firm.
D. PCAOB guidance.

94. Which of the following would be considered “the nature of a misstatement” that might make it material?
A. Comparing the sum of known and projected misstatements to total current assets.
B. Comparing the sum of known and projected misstatements to total current liabilities.
C. Comparing the sum of known and projected misstatements to pretax income.
D. Having the effect of changing a positive earnings trend to a negative earnings trend.

95. An audit firm culture that emphasizes “doing the right thing” does not incorporate which of the following to
enhance audit quality?
A. Encouraging auditors to seek consultation with other members of the audit firm.
B. Yielding to management’s demands in order to promote additional service engagements.
C. Taking sufficient time to deal with difficult client issues.
D. Emphasizing long-term reputation over the immediate satisfaction of client preferences.
96. Which of the following are categories that do not reflect the contingent nature of losses and the guiding
criteria organized around probability of outcomes as provided by the FASB?
A. Guaranteed.
B. Reasonably possible.
C. Remote.
D. Probable.

97. Which of the following types of information is not a type of evidence that the auditor should obtain
concerning contingencies?
A. Information about major contracts in which contingencies may be present.
B. Documentation of communication with internal and external legal counsel of the client.
C. Accounts receivable confirmations.
D. Documentation of contingent liabilities contained in corporate minutes, correspondence from governmental
agencies, and bank confirmations.

98. Which of the following items does the auditor ask the client to send to its legal counsel requesting
information about asserted claims?
A. A letter of audit inquiry.
B. A management representation letter.
C. A management letter.
D. A loss reserve confirmation.

99. Which of the following items is not typically requested from the lawyer of a company regarding
contingencies?
A. Any limitations on the lawyer’s response such as not devoting substantial attention to the item or that the
amounts are not material.
B. Information about the attorney’s other clients with similar contingencies.
C. A description of each contingency, as well as progress and action that the company plans to take.
D. A comment on the completeness of management’s list of contingencies and an evaluation.

100. When responding to the auditor as a result of the audit client's letter of inquiry, how might the attorney
limit the response?
A. Limit the response to litigations in process.
B. Limit the response to asserted claims.
C. Limit the response to matters to which the attorney has given substantive attention in the form of legal
consultation or representation.
D. Limit the response to items which the attorney believes will result in loss to the client.
101. Which of the following parties has the responsibility for designing and maintaining policies and procedures
to identify, evaluate, and account for contingencies?
A. Management.
B. The auditor.
C. The audit committee.
D. The client's attorney.

102. When requiring a letter of audit inquiry from the client's attorney, which of the following information will
be requested?
A. A statement regarding conflicts of interest that the attorney may have with the client.
B. The attorney's expert opinion of proper GAAP treatment related to client contingencies.
C. An evaluation of the likelihood of unfavorable outcome of, and estimated losses from contingencies.
D. Possible auditor defenses for third-party litigation related to ordinary negligence claims.

103. Assume a situation in which an attorney who provided significant litigation counsel to a client to refuses to
furnish information requested in an audit. Which of the following descriptions best describes this situation from
the auditor’s perspective?
A. A departure from GAAP.
B. A scope limitation.
C. A violation of the attorney-client privilege.
D. A contingent liability.

104. Fulton Educational Company, Inc. has a matter of material litigation that is threatened, but that has not
gone to trial. The auditor's consideration of such a matter will not include which of the following?
A. Sending a letter to the client's attorneys for more information.
B. Discussing the matter with the client and their insurance adjuster.
C. Confirming with the harmed party regarding the amount that will be claimed.
D. Assessing whether accrual or disclosure by the client was reported in accordance with GAAP.

105. In the letter of audit inquiry concerning a description and evaluation of litigation, claims and assessment
provided by management to the auditor, which of the following is the client’s lawyer not requested to provide?
A. Information on the completeness of management’s list.
B. Information on the compliance of the disclosures with GAAP.
C. Information on the likelihood and range of possible losses.
D. Information on any limitations on the lawyer’s response.
106. When evaluating accounting estimates, the auditor would not concentrate on which of the following key
factors and assumptions?
A. Those that are within budgetary expectations.
B. Those that are subjective and susceptible to misstatement and bias.
C. Those that are inconsistent with current economic trends.
D. Those that are sensitive to variations.

107. In evaluating the reasonableness of an estimate, the auditor would not normally concentrate on which of
the following factors and assumptions?
A. Subjective judgments that introduce bias.
B. Deviations from historical patterns.
C. Amounts that are inconsistent with current economic trends.
D. All of these are a focus of the auditor regarding reasonable estimates.

108. Which of the following is not a reason why the auditor needs to take special care to review significant
estimates in the financial statements?
A. Organizations may try to use the estimates to “smooth” earnings.
B. Organizations may create hidden reserves in unusually good years that can be used in years when real profits
do not meet expectations.
C. Companies may underestimate liabilities or impairment of asset values to achieve reported earning goals in
years when real profits to not meet expectations.
D. Companies may try to overestimate liabilities in computing leverage ratios.

109. Which of the following is not true regarding accounting estimates?

A. Accounting estimates are based on management’s knowledge and experience of past and current events.
B. Accounting estimates are based on management’s assumptions about conditions that are expected to exist
and courses of action the company expects to take.
C. Accounting estimates are based on both subjective and objective factors
D. Because accounting estimates are based, in part, on management’s knowledge and experience, they are not
biased.

110. The client makes estimates relative to recorded amounts in the financial statements. Which of the
following assumptions best represents the auditor's primary focus regarding the reasonableness of such
estimates?
A. That historical trends are followed.
B. That income is managed.
C. That there is an adequate cushion.
D. That management reverses estimates when opportune.
111. Which of the following is false regarding the use of an audit checklist for disclosures?
A. It is a convenient documentation format.
B. It reminds the auditor of matters that should be considered for disclosure.
C. It can be organized to include relevant professional guidance.
D. It covers all potential unusual circumstances.

112. Which one of the following is false regarding the adequacy of disclosures in a financial statement audit?
A. The auditor should consider matters for disclosure while gathering evidence during the course of the audit,
not just at the end of the audit.
B. One of the key disclosures is a summary of significant accounting policies used by the company.
C. Disclosures should be limited to only checklist items.
D. The auditor’s report does not specifically cover the statements made by management in the “Management
Discussion and Analysis” (MD&A) section of the annual report.

113. Assessing disclosures does not require reasonable assurance of which of the following?
A. The disclosures are understandable to users.
B. Disclosed events and transactions have occurred and pertain to the entity.
C. All material and immaterial disclosures have been reported.
D. The information is disclosed accurately and at appropriate amounts.

114. Which of the following is a tool that is best used by the audit team to determine if the client has included
all disclosures?
A. Management representation letter.
B. GAAS.
C. Inquiry of the CFO.
D. Checklists.

115. Which of the following is not an inherent limitation in an auditor’s ability to detect material misstatements
relating to a client’s compliance with laws and regulations?
A. Laws and regulations often relate to operational issues within the entity that do not necessarily relate to the
financial statements, so the information systems relating to financial reporting may not capture noncompliance.
B. The legal implications of noncompliance are ultimately a matter for legal authorities to resolve, and are not a
matter about which the auditor can resolve.
C. Management may act to conceal noncompliance, or may override controls, or may intentionally misrepresent
facts to the auditor.
D. Auditors are not required to consider the applicable legal and regulatory frameworks that apply to the entity.
116. What should an auditor do when becoming aware of violations of the FCPA?
A. Contact foreign officials in the country where the client has business operations.
B. Notify the audit committee about the violations, their circumstance, and the effect on the financial
statements.
C. Contact the U.S. marshals.
D. Design internal controls to deter improper payments.

117. Which of the following is not a main provision of the Foreign Corrupt Practices Act of 1977 (FCPA)?
A. No U.S. person or companies that have securities listed on U.S. markets may make a payment to a foreign
official for the purpose of obtaining or retaining business.
B. Companies that have securities listed on U.S. markets must make and keep financial records that accurately
and fairly reflect the transactions of the company.
C. Designing and maintaining internal accounting controls is the role of internal auditors when management
conducts business in a foreign country.
D. Certain payments made to an official to expedite the performance of the duties that the official would already
be bound to perform are acceptable.

118. On what information does the auditor base a going concern evaluation?
A. On separate procedures.
B. On the management discussion and analysis (MD&A).
C. On information obtained from normal audit procedures performed to test management’s assertions.
D. On the statement of cash flows for the current period.

119. Which of the following is not an indicator of a potential going-concern problem?

A. Negative trends in profitability.
B. External matters increasing regulatory requirements.
C. Significant changes in competition.
D. An Altman Z-score above 3.0.

120. If the auditor concludes that there may be a going-concern problem, which of the following is not typically
evaluated to determine the reasonableness of management’s plans to overcome this problem?
A. Management’s assumption about increasing prices or market share in relationship to current industry
developments.
B. Management’s assumptions about cost savings related to a reduction in the work force should be recomputed
and evaluated to determine any hidden costs.
C. Management’s past track record related to delaying unnecessary expenditures.
D. Management’s assumptions about selling off assets and their relationship to current market prices.
121. If conclusion is drawn that there may be a going concern problem, which of the following should the
auditor do?
A. Withdraw from the engagement.
B. Issue a qualified or adverse opinion.
C. Identify and assess management's plan to overcome the problem.
D. Communicate this fact with management that is one level above the controller.

122. If the auditor concludes that there may be a going-concern problem with the client, which of the following
is the best course of action for the auditor to follow?
A. Issue a qualified opinion.
B. Identify and assess management's plan to overcome the situation.
C. Chart the negative trends as an addendum to the audit report.
D. Increase fees to cover the probable exposure.

123. Which one of the following would the auditor consider to be an indication of a potential going-concern
problem?
A. Loss of the controller to a competitor.
B. Improper reporting of internal controls by management.
C. Adverse key financial ratios.
D. Large increase to sales in the month previous to year-end.

124. Which one of the following is not a key condition indicating doubt about a client’s ability to continue as a
going-concern?
A. Adverse key financial ratios.
B. Employee strike that halts operations for several months.
C. Company has not paid dividends to date.
D. Default on bank debt.

125. The auditor is responsible for evaluating the likelihood of a client continuing as a going concern for a
reasonable period of time. What is considered to be a reasonable time period?
A. One year from the audit report date.
B. One year from the last day of field work.
C. One year from the balance sheet date.
D. Two years from the balance sheet date.
126. The auditor is responsible for evaluating the likelihood of a client not being a going concern for the next 12
months. What basis will the auditor use to assess this issue?
A. Management integrity.
B. Control environment.
C. Absolute assurance.
D. Substantial doubt.

127. Which of the following is not a potential indicator of going concern problems for a client?
A. Negative trends in key financial ratios.
B. Loss of key personnel.
C. Plan to sell nonessential assets.
D. Default on a loan.

128. If substantial doubt remains about going concern for a client at the end of the audit, then which of the
following reports should the auditor typically issue?
A. Issue an unqualified audit report.
B. Issue an unqualified audit report with an explanatory paragraph.
C. Issue a qualified report.
D. Issue an adverse report.

129. Which of the following is not a typical analytical procedure for the completion of the audit?
A. Ratio analysis.
B. Common-size analysis.
C. Changes from the prior year.
D. All of the above would typically be used.

130. Before releasing the audit report, which of the following would the auditor most likely do?
A. Issue a management letter.
B. Perform an analytical review.
C. Check on a schedule of partner rotation.
D. Estimate client fee for subsequent services to be performed.

131. During which of the following phases of the audit are analytical review procedures required by the auditing
standards?
A. The planning phase of the audit.
B. The final review phase of the audit.
C. Both the planning and final review phases of the audit.
D. Performance of tests of controls.
132. Which of the following statement is false regarding analytical procedures that help auditors assess the
overall final presentation of the financial statements?
A. By performing a final analytical review, the audit firm will identify any unusual, unexpected, or unexplained
relationships that should be resolved before the issuance of the audit report.
B. A basic five step process for using analytical procedures applies.
C. Analytical procedures provide evidence on whether certain relationships make sense in light of the
knowledge obtained during the audit.
D. Auditing standards require the use of analytical procedures in the final review phase of the audit to assist in
identifying ending account relationships that are unusual.

133. Which of the following activities is not a step in the process for using analytical procedures?
A. Define when the difference between the auditor’s expectation and the client’s balance would be considered
significant.
B. Compute the difference between the auditor’s expectation and the client’s balance.
C. Perform appropriate followup on all material and immaterial differences.
D. Develop an expectation.

134. Analytical procedures conducted at the end of an audit are performed to examine trends and
changes. What is typically another purpose of analytical procedures at the end of the audit?
A. To document planning in accordance with GAAS.
B. To provide the client with a value added service in conjunction with audit activities.
C. To ask "hard questions" about the company's results and its relationship to external factors.
D. To increase the amount of items reported in the management letter.

135. Which of the following procedures is the least useful analytical procedure to indicate that further audit
work needs to be performed before rendering the audit opinion?
A. Developing a common-size analysis.
B. Analyzing the dollar and percentage changes in each income statement item over the previous year.
C. Comparing current earnings per share with earnings per share of the client’s primary competitor.
D. Developing a ratio analysis.

136. Which of the following is not a purpose of the management representation letter?
A. It reminds management of its responsibility for the financial statements.
B. It confirms oral responses obtained by the auditor earlier in the audit and the continuing appropriateness of
those responses.
C. It decreases the possibility of misunderstanding concerning the matters that are the subject of the
representations.
D. It implies that the auditor is responsible for the design of the internal controls.
137. Management of AllTech, Inc. refuses to sign the management representation letter given to them in the
course of the audit on the grounds that it invades the company's privacy. What does this refusal constitute?
A. A violation of full and fair disclosure.
B. A securities law violation.
C. A scope limitation.
D. A breakdown in internal controls.

138. Which one of the following is not a purpose of the management representation letter?
A. It clearly documents the audit procedures that were performed by the auditors.
B. It further acknowledges management's responsibility for the financial statements.
C. It confirms oral responses obtained by the auditor earlier in the audit and the continuing appropriateness of
those responses.
D. It reduces the possibility of misunderstanding concerning the matters that are the subject of the
representations.

139. Which of the following individuals should sign the management representation letter?
A. The members of the audit committee and board of directors.
B. The chief executive officer and the chief financial officer.
C. The chief financial officer and the treasurer.
D. The controller and the auditor.

140. The date of the audit opinion of Upton Industries, Inc. reads: March 7, 2014 except for Note D, as to which
the date is March 12, 2014. What is this an example of?
A. Improper reporting.
B. A GAAP violation.
C. Dual dating.
D. A contingent event.

141. Assume that a major customer of the company that you are auditing files for bankruptcy during the
subsequent period because of a deteriorating financial condition. Neither you nor the client becomes aware of
the event until the bankruptcy filing is reported. What type of subsequent event would this be?
A. Type I subsequent event
B. Type II subsequent event
C. Neither Type I or Type II
D. Both Type I and Type II
142. Which of the following would be a Type II subsequent event?
A. Information becomes available that provides evidence about the valuation of an estimate or reserve that had
been accrued at year end.
B. A sale of inventory below carrying value provides evidence that the net realizable value was less than cost at
year end.
C. A stock dividend or split that takes place during the subsequent period should be disclosed. In addition,
earnings-per-share figures should be adjusted to show the retroactive effect of the stock dividend or split.
D. A material change occurs in the value of investment securities after the balance sheet date.

143. Which one of the following subsequent events will least likely result in an adjustment to the financial
statements?
A. Material change in the amount of settlement of a lawsuit which had been estimated at year end.
B. Bankruptcy of a customer who owes your client a material amount on open account at year end for which
there is an inadequate allowance estimate.
C. Sale of a large block of inventory at a price materially below carrying value.
D. Signing of a letter-of-intent by the client to acquire 55% of another entity for stock.

144. Which one of the following would be the most effective procedure for discovering material Type II
subsequent events?
A. Updating the search for unrecorded liabilities.
B. Resending all bank confirmations returned.
C. Reading of the minutes of board of directors' meetings
D. Surprise cash count at random locations.

145. After completing the audit report of Blair Corporation, but before delivering the audit report to the client, a
tornado demolished the main production facility. In this case, what option is available to the auditor other than
dual dating the report?
A. Use the original audit report date.
B. Go back to the client's office and extend testing to the date of the tornado, thereby taking responsibility for
all events up to the date of the tornado.
C. Report the situation in the management representation letter.
D. Issue a scope limitation.

146. When a subsequent event provides evidence about conditions that existed at the balance sheet date, what is
the best course of action for the auditor to follow?
A. Assign a specialist.
B. Ensure that the financial statements are adjusted to reflect the information, including any necessary footnote
disclosures.
C. Shop for an opinion that fits the desired type of event.
D. Provide management with a new engagement letter to document the terms of the revised arrangement.
147. When a subsequent event provides evidence about conditions that did not exist at the balance sheet date,
what is the best course of action for the auditor to follow?
A. Ensure that any necessary footnote disclosures be included with the statements.
B. Ensure that the financial statements are adjusted to reflect the information, including any necessary footnote
disclosures.
C. Give an inappropriate opinion.
D. Provide management with a new engagement letter to document the terms of the revised arrangement.

148. Which of the following is the best example of a Type I subsequent event?
A. A related-party transaction occurs during the course of the audit.
B. The company defaults on its line-of-credit with the bank subsequent to year end but previous to the release of
the audit opinion.
C. Litigation that was accrued as a liability in the year under audit is settled subsequent to year-end for an
amount in excess of estimates.
D. The company initiates an initial public offering subsequent to year-end.

149. Which one of the following is not an example of an additional procedure that typically relates to the
discovery of subsequent events?
A. Partner review of all workpapers.
B. Reading interim financial statements and comparing them to the audited statements to note significant
changes.
C. Reading the board of directors' minutes for all meetings during the year and after year- end through the end
of field work.
D. Management inquiry.

150. Which one of the following is the best example of a Type II subsequent event?
A. Election of new board members.
B. Change in auditors.
C. Inability to collect from a significant customer.
D. Acquisition of a subsidiary.

151. Which of the following correctly states the period for which the auditor is responsible for subsequent
events?
A. The balance sheet date to the date the audit report is issued.
B. The balance sheet date to the end of field work.
C. The balance sheet date to the date of subsequent discovery of omitted procedures.
D. All of the above.
152. After an audit report is issued, the auditor discovers through a peer review that an important audit
procedure has been omitted. In this case, what should the auditor do?
A. Notify all parties known to be relying on the report.
B. Immediately request the client recall the report.
C. Contact his or her professional liability insurance carrier.
D. Determine whether the report can still be supported in light of the omitted procedure.

153. If the auditor failed to confirm receivables when that should have been done and it may be too late to
confirm now, what should the auditor do?
A. Issue an adverse opinion.
B. Extend the previous work done on subsequent collections to help determine that the receivables existed and
were properly valued at the balance sheet date
C. Automatically decide that the previously issued audit report cannot be supported in light of the omitted
procedures.
D. Issue a disclaimer of opinion.

154. Which of the following procedurea is not performed as part of an engagement quality review?
A. Evaluate judgments about materiality and the disposition of corrected and uncorrected identified
misstatements.
B. Call each board member to discuss the potential for fraud.
C. Confirm with the lead audit partner that there are no significant unresolved matters.
D. Evaluate whether appropriate levels of supervision and reviews of individual audit tasks were completed
adequately during the audit.

155. Which of the following is explicitly required by the Sarbanes-Oxley Act of 2002 for audits of public
companies?
A. Subsequent event review.
B. Engagement quality review.
C. Disclosure of all contingent liabilities.
D. Seven year client rotation.

156. The partner performing an engagement quality review will review the working papers and financial
statements but will not perform which of the following?
A. Assess completeness of the audit work and sufficiency of the evidence.
B. Determine the adequacy of financial statement disclosures.
C. Raise questions about the reasonableness of various financial statement presentations.
D. Perform a substantial portion of the audit procedures as an additional check.
157. An additional partner review of the audit and its findings is typically performed by an experienced member
of the firm. Which of the following individuals is most qualified to perform this concurring partner review?
A. The engagement partner who has worked on the client for three years.
B. An employee of the enforcement division of the SEC.
C. An experienced partner of the firm who did not actively participate on the audit.
D. A partner of another firm or office who knows the client well and who was a vital member of the audit team.

158. Which of the following is not a typical communication between the auditor and the audit committee?
A. The auditor should clearly communicate the auditor’s responsibility under Generally Accepted Auditing
Standards (GAAS).
B. The auditor should clearly communicate the planned scope of the audit engagement with the audit committee
and discuss its adequacy.
C. The auditor and management should discuss issues related to the retention of both client staff and audit firm
staff during the period of audit.
D. All major accounting disagreements with management, even if eventually resolved, should be discussed with
the audit committee.

159. If the audit team encounters difficulties in performing an audit, who should the audit team communicate
these matters to?
A. The SEC.
B. The audit committee.
C. Management.
D. The PCAOB.

160. Which of the following is not a required communication with the audit committee?
A. Auditor’s responsibility under GAAS.
B. Analytical review.
C. Audit adjustments.
D. Uncorrected misstatements.

161. Which of the following is not a required communication with the audit committee?
A. Accounting policies.
B. Accounting estimates.
C. Economic trends.
D. Difficulties encountered.
162. What is the letter called that is drafted by the auditor and reports observations to management which may
help management perform more effectively?
A. The letter of reportable conditions.
B. The management representation letter.
C. The management letter.
D. The contingent events document.

163. Which of the following is false regarding the management letter?

A. The management letter is not required
B. The management letter is the same as the management representation letter.
C. The management letter helps to provide management comfort that the auditor has done a quality job.
D. The management letter helps provide management with information that the auditor knows and understands
the client’s business.

164. Where would the auditor make mention of issues noted during audit procedures that are not of audit
significance?
A. Engagement letter.
B. Management letter.
C. Representation letter.
D. Attorney letter.

165. Client continuance-related risks do not include which of the following key type of risk?
A. Client entity characteristics.
B. Quantitative risk factors.
C. Entity organizational or governance risks.
D. All of these are key types of client continuance-related risks.

166. Which of the following statements is false regarding partner rotation and audit firm rotation?
A. During a cooling off period, the individual or audit firm may not engage in any meaningful audit-related
interactions with the client.
B. Rules are the same internationally regarding the terms of mandatory partner rotation and mandatory audit
firm rotation.
C. The issue associated with mandatory partner or audit firm rotation is the familiarity threat.
D. Having a longstanding relationship with the client could aid audit quality because of the knowledge that the
partner and members of the engagement team gain through time.
167. Adjustments

In your audit of Lomar Company for the calendar year 2014, you find a number of items that you believe
represent possible adjustments to the company’s books. Management does not want to make any adjustments.

REQUIRED:

Assuming that Lomar is a public company describe how the adjustments might impact your audit report on
internal control over financial reporting.

168. Contingent liabilities

The auditor will discuss contingencies with the appropriate executives and management of the company.
Identify at least five sources of evidence to corroborate management's representations regarding contingencies.

169. Contingencies

Define what a contingency is, describe the auditor’s main concerns about them, and indicate how contingencies
should be dealt with by management and the auditor. Besides litigation, claims and assessments, what are some
other types of contingencies?
170. Litigation, claims, and assessments

Discuss the information management should provide related to litigation, claims and assessments. Also describe
the purpose of the letter of audit inquiry, who writes it, who it is addressed to, and the important inquiries that
are made of the client’s lawyer in the letter of audit inquiry.

171. Management responsibilities

Explain how management explicitly asserts their confidence and responsibility over the financial statements of
the company.

172. Disclosures

You are a staff auditor on the audit of Cosmo Technologies, Inc. The audit partner asks you to carefully read the
new mortgage contract with the Hometown Bank and abstract all pertinent information that might be needed for
a financial disclosure.

Required:
(1) List the information in a mortgage that is likely to be relevant to the auditor.
(2) What are the pros and cons of using a disclosure checklist for this task?
173. Final Analytical Procedures and Disclosures

When auditing Global Alliance Industries, Inc., the auditor performed extensive analytical procedures and
found the following:
(a) The commission expenses as a percentage of sales has stayed constant for several years, but has increased
significantly in the current year. However, commission rates have not changed.
(b) The rate of inventory turnover has steadily decreased for the past four years.
(c) The inventory as a percentage of current assets has steadily increased for the past four years.
(d) The number of days’ sales in accounts receivable has steadily increased for three years.
(e) The allowance for uncollectible accounts as a percentage of accounts receivable has steadily decreased for
three years.
(f) The absolute amounts of depreciation expense and depreciation expense as a percentage of gross fixed assets
are significantly smaller than in the preceding year.

REQUIRED:

(1) Evaluate the significance of not disclosing or adjusting these items, if material, in the fair presentation of
financial statements.

(2) When assessing disclosures, what criteria do auditors use?

174. Analytical procedures

What is the purpose of using analytical review procedures in the final review stages of the audit?
175. Management representation letters

Describe the purpose of the management representation letter.

176. Management representation letters

Barrett Jennings, CPA, has prepared a letter of representation for the president and controller to sign. The
following items are contained in it:

(a) Inventory is fairly stated at the lower of cost or market and includes no obsolete items.
(b) All actual and contingent liabilities are properly included in the financial statements.
(c) All subsequent events, relevant to the financial statements, have been disclosed.

Required:

(1) Why is it desirable to have a letter of management representation letter from the client concerning these
matters when the evidence accumulated during the course of the audit is meant to verify the same information?

(2) How is the letter of management representation useful as audit evidence?

(3) What are several other types of information commonly included in the management representation letter?
177. Subsequent events

What are the two types of subsequent events identified in the accounting literature and what is required when
each occurs? Provide an example of each type of subsequent event.

178. Testing subsequent events

List the audit procedures to be performed to determine if subsequent events have occurred and have been
appropriately addressed.

179. Type I subsequent events

Provide two examples of a Type I subsequent event and explain how these events would be treated in the
financial statements.
180. Type II subsequent events

Provide two examples of a Type II subsequent event and explain how these events would be treated in the
financial statements.

181. Dual-dating opinions

Describe the concept and the purpose of dual-dating an audit report.

182. Engagement Quality Review

Morgan Thompson, CPA is a partner in a medium-sized CPA firm and takes an active part in the conduct of
every audit she supervises. She follows the practice of reviewing all audit files of staff auditors on her team as
soon as it is convenient, rather than waiting until the end of the audit. When the audit is nearly finished,
Thompson reviews the audit files again to make sure that she has not missed anything significant. Because she
makes most of the major decisions on the audit, there is rarely anything that requires further
investigation. When she completes the review, she prepares a draft of the financial statements, gets them
approved by management, and has them assembled in her firm’s office. No other partner reviews the audit
documentation, because Thompson is responsible for signing the audit reports.

REQUIRED:

(1) Evaluate the practice of not having a concurring partner review of the audit documentation by another
partner in the firm, (2) explain some of the procedures the reviewer should perform as part of the review
process, and (3) what documentation should be included.

183. Management letters to clients

What is a management letter and how does it differ from a management representation letter?
184. Client Acceptance

Newburg Company is in an industry in the early development stage, where there are minimal barriers to entry to
the client’s business model. Newburg Company’s audit committee decided to put their 2014 audit out for
bids. One of the Big Four CPA firms had performed their audits from 2011-2013, and although happy with the
previous auditor, the audit committee believed they should rotate to another firm. On the last audit, the Big
Four’s audit fees were $500,000. Barnaby, CPAs, came in as the low bidder, making a proposal to Newburg
Company regarding audit fees for 2014. Their proposed audit fee was $250,000.

Required:

(1) Based on this scenario, describe the ethical decisions that an auditor must make during portfolio
management decisions such as the client acceptance and client continuance decision. What is the relationship
between ethics and high audit quality?

(2) What issues should the client’s audit committee consider before going with the lowest bid?
Chapter 14: Activities Required in Completing a Quality Audit
Key

1. Review activities that are completed towards the end of the audit are quite varied.
TRUE

2. Misstatements that are detected, but individually are not material, should be ignored when determining the
appropriate audit report.
FALSE

3. Most audit firms use a schedule to accumulate the known and projected misstatements and the carryover
effects of prior-year uncorrected misstatements.
TRUE

4. At the end of an audit, adjustments that are “waived” will remain uncorrected.
TRUE

5. The auditor compares the total likely misstatements to each significant segment of the financial statements,
such as total current assets, total noncurrent assets, total current liabilities, total noncurrent liabilities, owners’
equity, and pretax income, to determine if they are, in aggregate, material to the financial statements.
TRUE

6. The total likely misstatements found during the audit are equal to the sum of known and projected
misstatements.
TRUE

7. The materiality of a misstatement is based on only the quantitative amount of the misstatement.
FALSE
8. An audit firm culture that emphasizes “doing the right thing,” encourages auditors to deal with difficult issues
in a short period of time.
FALSE

9. A culture that encourages auditors to seek consultation with other members of the audit firm will be more
likely to result in auditors who will acquiesce to inappropriate or aggressive client preferences.
FALSE

10. PCAOB AS 14 provides important insight that auditors must consider as they decide whether management’s
refusal to correct a detected misstatement is indicative of intentional bias.
TRUE

11. In an integrated audit, if one or more material weaknesses exist, the auditor will need to issue a qualified
opinion on internal control over financial reporting.
FALSE

12. Multiple internal control deficiencies in the same cycle may actually decrease the likelihood of misstatement
in that cycle.
FALSE

13. FASB has set forth four categories of potential losses that can be reasonably estimated.
FALSE

14. Auditors are responsible for designing and maintaining policies and procedures to identify, evaluate, and
account for contingencies.
FALSE

15. The primary sourceof evidence concerning contingencies is the client’s external attorney.
FALSE

16. Regarding loss contingencies, legal counsel should be instructed by the client to respond directly to the
auditors.
TRUE
17. If a lawyer refuses to furnish the requested information about the client’s contingencies to the auditor, the
auditor should issue an unqualified audit opinion.
FALSE

18. Property and casualty insurance premiums are examples of estimates found on financial statements.
FALSE

19. Auditors should have heightened skepticism regarding period-end adjusting journal entries that relate to
accounts with significant estimates.
TRUE

20. Estimates are based on both subjective and objective factors.

TRUE

21. Events or transactions occurring after the balance sheet date and before the audit report date, can be useful
in identifying and evaluating the reasonableness of estimates.
TRUE

22. A deviation from historical patterns is one of the factors that an auditor focuses on when evaluating the
reasonableness of an estimate.
TRUE

23. The auditor should consider the historical experience of the client in making past estimates.
TRUE

24. A policy providing a reserve for returned products at the original sales price rather than at replacement cost
violates GAAP.
TRUE

25. If the auditor determines that informative disclosures are not reasonably adequate, the auditor must identify
that fact in the auditor’s report.
TRUE
26. Disclosures can be made either on the face of the financial statements in the form of classifications or in
parenthetical notations and/or in the notes to the statements.
TRUE

27. A disclosure checklist is a convenient documentation format for evidence that the auditor adequately
evaluated the client’s disclosures.
TRUE

28. The auditor should consider matters for disclosure only while gathering evidence during the course of the
audit.
FALSE

29. The auditor’s report specifically covers the statements and disclosures made by management in the
“Management Discussion and Analysis” (MD&A) section of the annual report.
FALSE

30. Auditors routinely review the MD&A to provide reasonable assurance that it does not contain information
that is factually inaccurate or inconsistent with the audited portion of the financial statements and
accompanying footnotes.
TRUE

31. Noncompliancewith laws and regulations includes only acts of omission by the entity that are considered to
be unintentional and contrary to the prevailing laws or regulations.
FALSE

32. Auditing standards recognize that there are inherent limitations in an auditor’s ability to detect material
misstatements relating to the entity’s compliance with laws and regulations.
TRUE

33. Auditors are responsible for obtaining reasonable assurance that the financial statements are free from
material misstatements, including material misstatements related to noncompliance with laws and regulations.
TRUE
34. When obtaining reasonable assurance that the financial statements are free from material misstatements,
auditors should consider the applicable legal and regulatory frameworks that apply to the entity.
TRUE

35. If management or those charged with governance do not demonstrate a commitment to internal control over
noncompliance with laws and regulations, then the auditor should withdraw from the engagement.
FALSE

36. According to the Foreign Corrupt Practices Act of 1977 (FCPA), companies that have securities listed on
U.S. markets must make and keep financial records that accurately and fairly reflect the transactions of the
company and design and maintain an adequate system of internal accounting controls.
TRUE

37. If an auditor becomes aware of violations of the Foreign Corrupt Practices Act of 1977 (FCPA), the auditor
should notify the CFO about the violations, their circumstance, and the effect on the financial statements.
FALSE

38. If a client makes payments to a middle-man who uses the funds to obtain corporate tax refunds for the client
from government officials, this is not considered a violation of the Foreign Corrupt Practices Act of 1977
(FCPA).
FALSE

39. Auditors are required to evaluate the likelihood of each client continuing as a going concern for a reasonable
period into the foreseeable future.
TRUE

40. If the auditor continues to have substantial doubt about the client continuing as a going concern, the auditor
should evaluate the adequacy of the client’s related disclosures.
TRUE

41. An audit opinion is a guarantee that the business is a going concern.

FALSE
42. The going-concern evaluation must be based on separate procedures that test the client’s ability to continue
as a going concern.
FALSE

43. Two paragraphs should be added to the auditor’s report when the auditor concludes that substantial doubt
remains about the client’s ability to continue as a going concern for a reasonable period of time.
FALSE

44. Management will often resist a going-concern modification because investors, lenders, and customers may
lose faith in the business.
TRUE

45. Some auditors may be reluctant to issue a going-concern audit opinion because it may hasten the failure of
the client company.
TRUE

46. Significant changes in the competitive market and a decrease in the competitiveness of the client’s products
are potential indicators of going-concern problems.
TRUE

47. A number of studies of bankruptcies have shown that certain combinations of ratios, like the Altman Z-
score, have good predictive power in indicating the likelihood of bankruptcy.
TRUE

48. Research has shown that auditors’ qualifications of audit reports are better predictors of going-concern
problems than are Z-score models.
FALSE

49. Analytical procedures help auditors assess the overall presentation of the financial statements.
TRUE
50. By performing a final analytical review, the audit firm will identify any unusual, unexpected, or unexplained
relationships that should be resolved before the issuance of the audit report.
TRUE

51. Analytical procedures may indicate that new controls need to be designed before completing the audit.
FALSE

52. Ratio analysis, common-size analysis, and analysis of the dollar and percentage changes in each income
statement item over the previous year are useful for this purpose.
TRUE

53. Analytical procedures conducted during the final review phase of the audit should corroborate conclusions
formed during the audit, which enables the auditor to draw conclusions upon which to base the audit opinion.
TRUE

54. When management is unable to provide an explanation for a previously unrecognized risk identified through
the analytical procedures, the auditor must issue an adverse opinion.
FALSE

55. The auditor should apply a basic three-step process for using analytical procedures during the final review.
FALSE

56. The auditor’s expectations in final analytical procedures must be more precise than those for substantive
analytics.
FALSE

57. The signing officers for the certifications under the Sarbanes-Oxley Act are typically the controller and the
treasurer of the company.
FALSE

58. In a quality audit, the auditor will review management’s processes for certification to provide reasonable
assurance that those processes are adequate and that they can be relied upon.
TRUE
59. Auditors should obtain a management representation letter at the end of each audit.
TRUE

60. Management’s refusal to sign the management representation letter is considered a scope limitation
sufficient to preclude the issuance of an unqualified opinion.
TRUE

61. Type I subsequent events indicate conditions that did not exist at the balance sheet date, but that may require
disclosure.
FALSE

62. An example of a Type I subsequent event would be a significant lawsuit that is initiated relating to an
incident that occurred after the balance sheet date.
FALSE

63. Procedures such as a cutoff test and a search for unrecorded liabilities are related to subsequent events.
TRUE

64. When the auditor becomes aware of an event that occurs after the audit report date, but before the issuance
of the audit report to the client and the event is disclosed in the footnotes, the auditor would date the report as if
this fact had been known at year-end.
FALSE

65. If the auditor decides that steps should be taken to prevent further reliance on the financial statements and
audit report due to subsequent events after issuance of the audit report, the auditor should not try to obtain client
cooperation, but should immediately notify any regulatory agency having jurisdiction over the client, such as
the SEC, that the audit report should no longer be associated with the client’s financial statements.
FALSE

66. An additional procedure related to subsequent events is the reading of the meeting minutes for the board of
directors meeting.
TRUE
67. If an omission of an important audit procedure is discovered, the auditor should immediately issue a
disclaimer of opinion for the audit.
FALSE

68. If omitted audit procedures cannot be performed, the auditor should extend previous work done and modify
the report, if necessary.
TRUE

69. Typically, omissions may be discovered when audit documentation is reviewed as part of an external or
internal review program.
TRUE

70. When it is discovered that an important audit procedure was not performed, the SEC imposes sanctions
against the audit firm responsible.
FALSE

71. As part of a quality audit, the audit firm must have policies and procedures in place for conducting an
engagement quality review of each audit before issuing the audit opinion for public companies.
TRUE

72. If an experienced reviewer who was not a part of the audit team, but who has appropriate competence,
independence, integrity, and objectivity, performs an independent quality review, this is referred to as a
reoccurring partner review.
FALSE

73. The engagement quality review is a risk-based review.

TRUE

74. The audit documentation when performing an engagement quality review should include such information
such as how much the firm paid for the review.
FALSE
75. It is important that the external auditor have a constructive and detailed dialogue with the audit committee
on important aspects of the audit.
TRUE

76. The audit committee is typically independent of the board of directors.

FALSE

77. All major accounting disagreements with management, even if eventually resolved, should be discussed
with the audit committee.
TRUE

78. The auditor generally reports things that management could do better in a management letteras a
constructive part of the audit.
TRUE

79. A management letter is the same as a management representation letter.

FALSE

80. A management letter is not required.

TRUE

81. After the auditor completes the current audit, an issue of importance for subsequent year audits is mandatory
partner rotation.
TRUE

82. Audit firm culture plays a role in audit firm portfolio management in that some audit firms are willing to
provide audits to riskier clients, while other audit firms are not willing to do so.
TRUE

83. In addition to risk factors, an important consideration in client continuance decisions involves the audit
firm’s growth strategy.
TRUE
84. Audit firm portfolio management decisions are not important in achieving audit quality.
FALSE

85. If an audit firm accepts or continues to provide audits to a client firm with ineffective internal controls over
financial reporting, the management representation letter will note that an adverse opinion will likely be issued.
FALSE

86. The familiarity threat is the most relevant issue for mandatory partner or audit firm rotation.
TRUE

87. Rules are standardized internationally in terms of mandatory partner rotation and mandatory audit firm
rotation.
FALSE

88. A cooling off period is the number of years after which the individual auditor or audit firm may resume its
prior role with the audit client.
TRUE

89. The AICPA Auditing Standards Board (ASB) requires a 5-year mandatory cooling off period for partner
rotation.
FALSE

90. The Public Company Accounting Oversight Board (PCAOB) requires mandatory audit firm rotation after
six years, with a cooling off period of four years.
FALSE

91. Most audit firms use a schedule to accumulate the known and projected misstatements and the carryover
effects of prior-year uncorrected misstatements. Which of the following statements regarding this process is
false?
A. Adjustments made to correct the financial statements are referred to as booked.
B. Possible adjustments to the financial statements that are left uncorrected are referred to as waived.
C. Tax effects are not shown on schedules of correcting errors.
D. The nature of the misstatement, as well as the quantitative amount, is considered in the judgment of
materiality.
92. During the course of an audit, misstatements that are individually immaterial may be detected. What should
the auditor do with these?
A. Permanently pass on these immaterial misstatements as they do not individually impact the financial
statements.
B. Request that management footnote the immaterial misstatements in the financial statements for fair
presentation.
C. Accumulate all of the known and projected misstatements to determine if the impact is material in the
aggregate.
D. Roll them forward for three years when they will become material enough to adjust.

93. Which of the following is one of the most important drivers of audit quality in cases where an auditor may
feel some pressure to acquiesce to management’s demands to not require that misstatements be corrected in
order to preserve a harmonious working relationship?
A. Firm culture.
B. Ethics training.
C. Annual income of the CPA firm.
D. PCAOB guidance.

94. Which of the following would be considered “the nature of a misstatement” that might make it material?
A. Comparing the sum of known and projected misstatements to total current assets.
B. Comparing the sum of known and projected misstatements to total current liabilities.
C. Comparing the sum of known and projected misstatements to pretax income.
D. Having the effect of changing a positive earnings trend to a negative earnings trend.

95. An audit firm culture that emphasizes “doing the right thing” does not incorporate which of the following to
enhance audit quality?
A. Encouraging auditors to seek consultation with other members of the audit firm.
B. Yielding to management’s demands in order to promote additional service engagements.
C. Taking sufficient time to deal with difficult client issues.
D. Emphasizing long-term reputation over the immediate satisfaction of client preferences.

96. Which of the following are categories that do not reflect the contingent nature of losses and the guiding
criteria organized around probability of outcomes as provided by the FASB?
A. Guaranteed.
B. Reasonably possible.
C. Remote.
D. Probable.
97. Which of the following types of information is not a type of evidence that the auditor should obtain
concerning contingencies?
A. Information about major contracts in which contingencies may be present.
B. Documentation of communication with internal and external legal counsel of the client.
C. Accounts receivable confirmations.
D. Documentation of contingent liabilities contained in corporate minutes, correspondence from governmental
agencies, and bank confirmations.

98. Which of the following items does the auditor ask the client to send to its legal counsel requesting
information about asserted claims?
A. A letter of audit inquiry.
B. A management representation letter.
C. A management letter.
D. A loss reserve confirmation.

99. Which of the following items is not typically requested from the lawyer of a company regarding
contingencies?
A. Any limitations on the lawyer’s response such as not devoting substantial attention to the item or that the
amounts are not material.
B. Information about the attorney’s other clients with similar contingencies.
C. A description of each contingency, as well as progress and action that the company plans to take.
D. A comment on the completeness of management’s list of contingencies and an evaluation.

100. When responding to the auditor as a result of the audit client's letter of inquiry, how might the attorney
limit the response?
A. Limit the response to litigations in process.
B. Limit the response to asserted claims.
C. Limit the response to matters to which the attorney has given substantive attention in the form of legal
consultation or representation.
D. Limit the response to items which the attorney believes will result in loss to the client.

101. Which of the following parties has the responsibility for designing and maintaining policies and procedures
to identify, evaluate, and account for contingencies?
A. Management.
B. The auditor.
C. The audit committee.
D. The client's attorney.
102. When requiring a letter of audit inquiry from the client's attorney, which of the following information will
be requested?
A. A statement regarding conflicts of interest that the attorney may have with the client.
B. The attorney's expert opinion of proper GAAP treatment related to client contingencies.
C. An evaluation of the likelihood of unfavorable outcome of, and estimated losses from contingencies.
D. Possible auditor defenses for third-party litigation related to ordinary negligence claims.

103. Assume a situation in which an attorney who provided significant litigation counsel to a client to refuses to
furnish information requested in an audit. Which of the following descriptions best describes this situation from
the auditor’s perspective?
A. A departure from GAAP.
B. A scope limitation.
C. A violation of the attorney-client privilege.
D. A contingent liability.

104. Fulton Educational Company, Inc. has a matter of material litigation that is threatened, but that has not
gone to trial. The auditor's consideration of such a matter will not include which of the following?
A. Sending a letter to the client's attorneys for more information.
B. Discussing the matter with the client and their insurance adjuster.
C. Confirming with the harmed party regarding the amount that will be claimed.
D. Assessing whether accrual or disclosure by the client was reported in accordance with GAAP.

105. In the letter of audit inquiry concerning a description and evaluation of litigation, claims and assessment
provided by management to the auditor, which of the following is the client’s lawyer not requested to provide?
A. Information on the completeness of management’s list.
B. Information on the compliance of the disclosures with GAAP.
C. Information on the likelihood and range of possible losses.
D. Information on any limitations on the lawyer’s response.

106. When evaluating accounting estimates, the auditor would not concentrate on which of the following key
factors and assumptions?
A. Those that are within budgetary expectations.
B. Those that are subjective and susceptible to misstatement and bias.
C. Those that are inconsistent with current economic trends.
D. Those that are sensitive to variations.
107. In evaluating the reasonableness of an estimate, the auditor would not normally concentrate on which of
the following factors and assumptions?
A. Subjective judgments that introduce bias.
B. Deviations from historical patterns.
C. Amounts that are inconsistent with current economic trends.
D. All of these are a focus of the auditor regarding reasonable estimates.

108. Which of the following is not a reason why the auditor needs to take special care to review significant
estimates in the financial statements?
A. Organizations may try to use the estimates to “smooth” earnings.
B. Organizations may create hidden reserves in unusually good years that can be used in years when real profits
do not meet expectations.
C. Companies may underestimate liabilities or impairment of asset values to achieve reported earning goals in
years when real profits to not meet expectations.
D. Companies may try to overestimate liabilities in computing leverage ratios.

109. Which of the following is not true regarding accounting estimates?

A. Accounting estimates are based on management’s knowledge and experience of past and current events.
B. Accounting estimates are based on management’s assumptions about conditions that are expected to exist
and courses of action the company expects to take.
C. Accounting estimates are based on both subjective and objective factors
D. Because accounting estimates are based, in part, on management’s knowledge and experience, they are not
biased.

110. The client makes estimates relative to recorded amounts in the financial statements. Which of the
following assumptions best represents the auditor's primary focus regarding the reasonableness of such
estimates?
A. That historical trends are followed.
B. That income is managed.
C. That there is an adequate cushion.
D. That management reverses estimates when opportune.

111. Which of the following is false regarding the use of an audit checklist for disclosures?
A. It is a convenient documentation format.
B. It reminds the auditor of matters that should be considered for disclosure.
C. It can be organized to include relevant professional guidance.
D. It covers all potential unusual circumstances.
112. Which one of the following is false regarding the adequacy of disclosures in a financial statement audit?
A. The auditor should consider matters for disclosure while gathering evidence during the course of the audit,
not just at the end of the audit.
B. One of the key disclosures is a summary of significant accounting policies used by the company.
C. Disclosures should be limited to only checklist items.
D. The auditor’s report does not specifically cover the statements made by management in the “Management
Discussion and Analysis” (MD&A) section of the annual report.

113. Assessing disclosures does not require reasonable assurance of which of the following?
A. The disclosures are understandable to users.
B. Disclosed events and transactions have occurred and pertain to the entity.
C. All material and immaterial disclosures have been reported.
D. The information is disclosed accurately and at appropriate amounts.

114. Which of the following is a tool that is best used by the audit team to determine if the client has included
all disclosures?
A. Management representation letter.
B. GAAS.
C. Inquiry of the CFO.
D. Checklists.

115. Which of the following is not an inherent limitation in an auditor’s ability to detect material misstatements
relating to a client’s compliance with laws and regulations?
A. Laws and regulations often relate to operational issues within the entity that do not necessarily relate to the
financial statements, so the information systems relating to financial reporting may not capture noncompliance.
B. The legal implications of noncompliance are ultimately a matter for legal authorities to resolve, and are not a
matter about which the auditor can resolve.
C. Management may act to conceal noncompliance, or may override controls, or may intentionally misrepresent
facts to the auditor.
D. Auditors are not required to consider the applicable legal and regulatory frameworks that apply to the entity.

116. What should an auditor do when becoming aware of violations of the FCPA?
A. Contact foreign officials in the country where the client has business operations.
B. Notify the audit committee about the violations, their circumstance, and the effect on the financial
statements.
C. Contact the U.S. marshals.
D. Design internal controls to deter improper payments.
117. Which of the following is not a main provision of the Foreign Corrupt Practices Act of 1977 (FCPA)?
A. No U.S. person or companies that have securities listed on U.S. markets may make a payment to a foreign
official for the purpose of obtaining or retaining business.
B. Companies that have securities listed on U.S. markets must make and keep financial records that accurately
and fairly reflect the transactions of the company.
C. Designing and maintaining internal accounting controls is the role of internal auditors when management
conducts business in a foreign country.
D. Certain payments made to an official to expedite the performance of the duties that the official would already
be bound to perform are acceptable.

118. On what information does the auditor base a going concern evaluation?
A. On separate procedures.
B. On the management discussion and analysis (MD&A).
C. On information obtained from normal audit procedures performed to test management’s assertions.
D. On the statement of cash flows for the current period.

119. Which of the following is not an indicator of a potential going-concern problem?

A. Negative trends in profitability.
B. External matters increasing regulatory requirements.
C. Significant changes in competition.
D. An Altman Z-score above 3.0.

120. If the auditor concludes that there may be a going-concern problem, which of the following is not typically
evaluated to determine the reasonableness of management’s plans to overcome this problem?
A. Management’s assumption about increasing prices or market share in relationship to current industry
developments.
B. Management’s assumptions about cost savings related to a reduction in the work force should be recomputed
and evaluated to determine any hidden costs.
C. Management’s past track record related to delaying unnecessary expenditures.
D. Management’s assumptions about selling off assets and their relationship to current market prices.

121. If conclusion is drawn that there may be a going concern problem, which of the following should the
auditor do?
A. Withdraw from the engagement.
B. Issue a qualified or adverse opinion.
C. Identify and assess management's plan to overcome the problem.
D. Communicate this fact with management that is one level above the controller.
122. If the auditor concludes that there may be a going-concern problem with the client, which of the following
is the best course of action for the auditor to follow?
A. Issue a qualified opinion.
B. Identify and assess management's plan to overcome the situation.
C. Chart the negative trends as an addendum to the audit report.
D. Increase fees to cover the probable exposure.

123. Which one of the following would the auditor consider to be an indication of a potential going-concern
problem?
A. Loss of the controller to a competitor.
B. Improper reporting of internal controls by management.
C. Adverse key financial ratios.
D. Large increase to sales in the month previous to year-end.

124. Which one of the following is not a key condition indicating doubt about a client’s ability to continue as a
going-concern?
A. Adverse key financial ratios.
B. Employee strike that halts operations for several months.
C. Company has not paid dividends to date.
D. Default on bank debt.

125. The auditor is responsible for evaluating the likelihood of a client continuing as a going concern for a
reasonable period of time. What is considered to be a reasonable time period?
A. One year from the audit report date.
B. One year from the last day of field work.
C. One year from the balance sheet date.
D. Two years from the balance sheet date.

126. The auditor is responsible for evaluating the likelihood of a client not being a going concern for the next 12
months. What basis will the auditor use to assess this issue?
A. Management integrity.
B. Control environment.
C. Absolute assurance.
D. Substantial doubt.
127. Which of the following is not a potential indicator of going concern problems for a client?
A. Negative trends in key financial ratios.
B. Loss of key personnel.
C. Plan to sell nonessential assets.
D. Default on a loan.

128. If substantial doubt remains about going concern for a client at the end of the audit, then which of the
following reports should the auditor typically issue?
A. Issue an unqualified audit report.
B. Issue an unqualified audit report with an explanatory paragraph.
C. Issue a qualified report.
D. Issue an adverse report.

129. Which of the following is not a typical analytical procedure for the completion of the audit?
A. Ratio analysis.
B. Common-size analysis.
C. Changes from the prior year.
D. All of the above would typically be used.

130. Before releasing the audit report, which of the following would the auditor most likely do?
A. Issue a management letter.
B. Perform an analytical review.
C. Check on a schedule of partner rotation.
D. Estimate client fee for subsequent services to be performed.

131. During which of the following phases of the audit are analytical review procedures required by the auditing
standards?
A. The planning phase of the audit.
B. The final review phase of the audit.
C. Both the planning and final review phases of the audit.
D. Performance of tests of controls.
132. Which of the following statement is false regarding analytical procedures that help auditors assess the
overall final presentation of the financial statements?
A. By performing a final analytical review, the audit firm will identify any unusual, unexpected, or unexplained
relationships that should be resolved before the issuance of the audit report.
B. A basic five step process for using analytical procedures applies.
C. Analytical procedures provide evidence on whether certain relationships make sense in light of the
knowledge obtained during the audit.
D. Auditing standards require the use of analytical procedures in the final review phase of the audit to assist in
identifying ending account relationships that are unusual.

133. Which of the following activities is not a step in the process for using analytical procedures?
A. Define when the difference between the auditor’s expectation and the client’s balance would be considered
significant.
B. Compute the difference between the auditor’s expectation and the client’s balance.
C. Perform appropriate followup on all material and immaterial differences.
D. Develop an expectation.

134. Analytical procedures conducted at the end of an audit are performed to examine trends and
changes. What is typically another purpose of analytical procedures at the end of the audit?
A. To document planning in accordance with GAAS.
B. To provide the client with a value added service in conjunction with audit activities.
C. To ask "hard questions" about the company's results and its relationship to external factors.
D. To increase the amount of items reported in the management letter.

135. Which of the following procedures is the least useful analytical procedure to indicate that further audit
work needs to be performed before rendering the audit opinion?
A. Developing a common-size analysis.
B. Analyzing the dollar and percentage changes in each income statement item over the previous year.
C. Comparing current earnings per share with earnings per share of the client’s primary competitor.
D. Developing a ratio analysis.

136. Which of the following is not a purpose of the management representation letter?
A. It reminds management of its responsibility for the financial statements.
B. It confirms oral responses obtained by the auditor earlier in the audit and the continuing appropriateness of
those responses.
C. It decreases the possibility of misunderstanding concerning the matters that are the subject of the
representations.
D. It implies that the auditor is responsible for the design of the internal controls.
137. Management of AllTech, Inc. refuses to sign the management representation letter given to them in the
course of the audit on the grounds that it invades the company's privacy. What does this refusal constitute?
A. A violation of full and fair disclosure.
B. A securities law violation.
C. A scope limitation.
D. A breakdown in internal controls.

138. Which one of the following is not a purpose of the management representation letter?
A. It clearly documents the audit procedures that were performed by the auditors.
B. It further acknowledges management's responsibility for the financial statements.
C. It confirms oral responses obtained by the auditor earlier in the audit and the continuing appropriateness of
those responses.
D. It reduces the possibility of misunderstanding concerning the matters that are the subject of the
representations.

139. Which of the following individuals should sign the management representation letter?
A. The members of the audit committee and board of directors.
B. The chief executive officer and the chief financial officer.
C. The chief financial officer and the treasurer.
D. The controller and the auditor.

140. The date of the audit opinion of Upton Industries, Inc. reads: March 7, 2014 except for Note D, as to which
the date is March 12, 2014. What is this an example of?
A. Improper reporting.
B. A GAAP violation.
C. Dual dating.
D. A contingent event.

141. Assume that a major customer of the company that you are auditing files for bankruptcy during the
subsequent period because of a deteriorating financial condition. Neither you nor the client becomes aware of
the event until the bankruptcy filing is reported. What type of subsequent event would this be?
A. Type I subsequent event
B. Type II subsequent event
C. Neither Type I or Type II
D. Both Type I and Type II
142. Which of the following would be a Type II subsequent event?
A. Information becomes available that provides evidence about the valuation of an estimate or reserve that had
been accrued at year end.
B. A sale of inventory below carrying value provides evidence that the net realizable value was less than cost at
year end.
C. A stock dividend or split that takes place during the subsequent period should be disclosed. In addition,
earnings-per-share figures should be adjusted to show the retroactive effect of the stock dividend or split.
D. A material change occurs in the value of investment securities after the balance sheet date.

143. Which one of the following subsequent events will least likely result in an adjustment to the financial
statements?
A. Material change in the amount of settlement of a lawsuit which had been estimated at year end.
B. Bankruptcy of a customer who owes your client a material amount on open account at year end for which
there is an inadequate allowance estimate.
C. Sale of a large block of inventory at a price materially below carrying value.
D. Signing of a letter-of-intent by the client to acquire 55% of another entity for stock.

144. Which one of the following would be the most effective procedure for discovering material Type II
subsequent events?
A. Updating the search for unrecorded liabilities.
B. Resending all bank confirmations returned.
C. Reading of the minutes of board of directors' meetings
D. Surprise cash count at random locations.

145. After completing the audit report of Blair Corporation, but before delivering the audit report to the client, a
tornado demolished the main production facility. In this case, what option is available to the auditor other than
dual dating the report?
A. Use the original audit report date.
B. Go back to the client's office and extend testing to the date of the tornado, thereby taking responsibility for
all events up to the date of the tornado.
C. Report the situation in the management representation letter.
D. Issue a scope limitation.

146. When a subsequent event provides evidence about conditions that existed at the balance sheet date, what is
the best course of action for the auditor to follow?
A. Assign a specialist.
B. Ensure that the financial statements are adjusted to reflect the information, including any necessary footnote
disclosures.
C. Shop for an opinion that fits the desired type of event.
D. Provide management with a new engagement letter to document the terms of the revised arrangement.
147. When a subsequent event provides evidence about conditions that did not exist at the balance sheet date,
what is the best course of action for the auditor to follow?
A. Ensure that any necessary footnote disclosures be included with the statements.
B. Ensure that the financial statements are adjusted to reflect the information, including any necessary footnote
disclosures.
C. Give an inappropriate opinion.
D. Provide management with a new engagement letter to document the terms of the revised arrangement.

148. Which of the following is the best example of a Type I subsequent event?
A. A related-party transaction occurs during the course of the audit.
B. The company defaults on its line-of-credit with the bank subsequent to year end but previous to the release of
the audit opinion.
C. Litigation that was accrued as a liability in the year under audit is settled subsequent to year-end for an
amount in excess of estimates.
D. The company initiates an initial public offering subsequent to year-end.

149. Which one of the following is not an example of an additional procedure that typically relates to the
discovery of subsequent events?
A. Partner review of all workpapers.
B. Reading interim financial statements and comparing them to the audited statements to note significant
changes.
C. Reading the board of directors' minutes for all meetings during the year and after year- end through the end
of field work.
D. Management inquiry.

150. Which one of the following is the best example of a Type II subsequent event?
A. Election of new board members.
B. Change in auditors.
C. Inability to collect from a significant customer.
D. Acquisition of a subsidiary.

151. Which of the following correctly states the period for which the auditor is responsible for subsequent
events?
A. The balance sheet date to the date the audit report is issued.
B. The balance sheet date to the end of field work.
C. The balance sheet date to the date of subsequent discovery of omitted procedures.
D. All of the above.
152. After an audit report is issued, the auditor discovers through a peer review that an important audit
procedure has been omitted. In this case, what should the auditor do?
A. Notify all parties known to be relying on the report.
B. Immediately request the client recall the report.
C. Contact his or her professional liability insurance carrier.
D. Determine whether the report can still be supported in light of the omitted procedure.

153. If the auditor failed to confirm receivables when that should have been done and it may be too late to
confirm now, what should the auditor do?
A. Issue an adverse opinion.
B. Extend the previous work done on subsequent collections to help determine that the receivables existed and
were properly valued at the balance sheet date
C. Automatically decide that the previously issued audit report cannot be supported in light of the omitted
procedures.
D. Issue a disclaimer of opinion.

154. Which of the following procedurea is not performed as part of an engagement quality review?
A. Evaluate judgments about materiality and the disposition of corrected and uncorrected identified
misstatements.
B. Call each board member to discuss the potential for fraud.
C. Confirm with the lead audit partner that there are no significant unresolved matters.
D. Evaluate whether appropriate levels of supervision and reviews of individual audit tasks were completed
adequately during the audit.

155. Which of the following is explicitly required by the Sarbanes-Oxley Act of 2002 for audits of public
companies?
A. Subsequent event review.
B. Engagement quality review.
C. Disclosure of all contingent liabilities.
D. Seven year client rotation.

156. The partner performing an engagement quality review will review the working papers and financial
statements but will not perform which of the following?
A. Assess completeness of the audit work and sufficiency of the evidence.
B. Determine the adequacy of financial statement disclosures.
C. Raise questions about the reasonableness of various financial statement presentations.
D. Perform a substantial portion of the audit procedures as an additional check.
157. An additional partner review of the audit and its findings is typically performed by an experienced member
of the firm. Which of the following individuals is most qualified to perform this concurring partner review?
A. The engagement partner who has worked on the client for three years.
B. An employee of the enforcement division of the SEC.
C. An experienced partner of the firm who did not actively participate on the audit.
D. A partner of another firm or office who knows the client well and who was a vital member of the audit team.

158. Which of the following is not a typical communication between the auditor and the audit committee?
A. The auditor should clearly communicate the auditor’s responsibility under Generally Accepted Auditing
Standards (GAAS).
B. The auditor should clearly communicate the planned scope of the audit engagement with the audit committee
and discuss its adequacy.
C. The auditor and management should discuss issues related to the retention of both client staff and audit firm
staff during the period of audit.
D. All major accounting disagreements with management, even if eventually resolved, should be discussed with
the audit committee.

159. If the audit team encounters difficulties in performing an audit, who should the audit team communicate
these matters to?
A. The SEC.
B. The audit committee.
C. Management.
D. The PCAOB.

160. Which of the following is not a required communication with the audit committee?
A. Auditor’s responsibility under GAAS.
B. Analytical review.
C. Audit adjustments.
D. Uncorrected misstatements.

161. Which of the following is not a required communication with the audit committee?
A. Accounting policies.
B. Accounting estimates.
C. Economic trends.
D. Difficulties encountered.
162. What is the letter called that is drafted by the auditor and reports observations to management which may
help management perform more effectively?
A. The letter of reportable conditions.
B. The management representation letter.
C. The management letter.
D. The contingent events document.

163. Which of the following is false regarding the management letter?

A. The management letter is not required
B. The management letter is the same as the management representation letter.
C. The management letter helps to provide management comfort that the auditor has done a quality job.
D. The management letter helps provide management with information that the auditor knows and understands
the client’s business.

164. Where would the auditor make mention of issues noted during audit procedures that are not of audit
significance?
A. Engagement letter.
B. Management letter.
C. Representation letter.
D. Attorney letter.

165. Client continuance-related risks do not include which of the following key type of risk?
A. Client entity characteristics.
B. Quantitative risk factors.
C. Entity organizational or governance risks.
D. All of these are key types of client continuance-related risks.

166. Which of the following statements is false regarding partner rotation and audit firm rotation?
A. During a cooling off period, the individual or audit firm may not engage in any meaningful audit-related
interactions with the client.
B. Rules are the same internationally regarding the terms of mandatory partner rotation and mandatory audit
firm rotation.
C. The issue associated with mandatory partner or audit firm rotation is the familiarity threat.
D. Having a longstanding relationship with the client could aid audit quality because of the knowledge that the
partner and members of the engagement team gain through time.
167. Adjustments

In your audit of Lomar Company for the calendar year 2014, you find a number of items that you believe
represent possible adjustments to the company’s books. Management does not want to make any adjustments.

REQUIRED:

Assuming that Lomar is a public company describe how the adjustments might impact your audit report on
internal control over financial reporting.

Auditors of public companies must evaluate the noted adjustments to determine their impact on the auditor’s
report on internal control over financial reporting. The audit of the financial statements and the audit of internal
control over financial reporting for a public company are to be integrated. Public company auditors must
consider the results of audit procedures performed to issue the audit report on the financial statements when
issuing the audit report on internal control. For example, if the possible adjustments identified for Lomar
Company are deemed to be material misstatements that were not initially identified by the company’s internal
controls, the auditor should consider this as at least a significant deficiency, if not a material weakness for
purposes of reporting on internal control. In this case, the auditor’s report on Lomar’s financial statements
would be unqualified as long as management corrected the misstatement before issuing the financial statements.
However, the auditor’s report on internal control over financial reporting would include an adverse opinion if
the auditor concludes that the company has one or more material weaknesses.

168. Contingent liabilities

The auditor will discuss contingencies with the appropriate executives and management of the company.
Identify at least five sources of evidence to corroborate management's representations regarding contingencies.

Corroborating evidence of contingent liabilities includes:

· letter of audit inquiry

· correspondence and invoices from lawyers
· corporate minutes
· contracts
· correspondence with governmental agencies
· bank confirmations
169. Contingencies

Define what a contingency is, describe the auditor’s main concerns about them, and indicate how contingencies
should be dealt with by management and the auditor. Besides litigation, claims and assessments, what are some
other types of contingencies?

Contingencies are potential gain or losses that management may incur because of what may or may not occur in
the future, e.g., a lawsuit against the client. In ASC 450 (formerly SFAS No. 5, “Accounting for
Contingencies”), the FASB provides the standard by which they are to be judged and dealt with. If they are
judged to be probable and reasonably estimable as of year-end, then management is responsible to accrue any
losses (gains are not recognized). Disclosure is required of contingencies that are probable but not estimable or
that are reasonably possible. Contingencies that are remote of occurrence don’t require disclosure unless it is a
common practice, for example, the guarantee of another company’s debt.

Besides litigation, claims and assessments, other types of contingencies include purchase and sales
commitments, agreements to repurchase receivables that have been sold, and guarantees of the debts of others.

170. Litigation, claims, and assessments

Discuss the information management should provide related to litigation, claims and assessments. Also describe
the purpose of the letter of audit inquiry, who writes it, who it is addressed to, and the important inquiries that
are made of the client’s lawyer in the letter of audit inquiry.

Management is the primary source of information concerning litigation, claims and assessments and should
provide the auditor with a description and evaluation of litigation, claims and assessments against them and
assurance that the accounting and disclosure requirements under SFAS No. 5 have been met. A level of
materiality should be agreed to between the client and the auditor.

To corroborate the information provided by management, other sources of information used by the auditor
include correspondence and invoices from the lawyers, corporate minutes, contracts, and bank confirmations.
The letter of audit inquiry though, written by the client to their chief legal counsel, is the primary source of
corroborative evidence concerning the litigations, claims and assessments against the client. Because of the
privileged relationship between the client and the lawyer, the client has to request any information from the
lawyer.The lawyer is requested to comment on the completeness of management’s list and to describe the
nature, progress, and likelihood and range of possible losses of those cases that they have devoted substantial
time to and to respond directly to the auditor. The lawyer should also indicate any limitations in the response. A
lawyer’s refusal to respond adequately is a scope limitation on the audit that would preclude an unqualified
opinion, but an inability to evaluate likelihood and range of loss because of inherent uncertainties is not
considered a scope limitation.
171. Management responsibilities

Explain how management explicitly asserts their confidence and responsibility over the financial statements of
the company.

The Sarbanes-Oxley Act requires certain members of management to certify that the financial statements are
presented in accordance with GAAP and certain securities acts. The CEO and CFO must sign a statement to this
effect. Some companies have extended this certification to divisional and subsidiary levels. Similar regulation
exists for management's responsibility over internal control.

172. Disclosures

You are a staff auditor on the audit of Cosmo Technologies, Inc. The audit partner asks you to carefully read the
new mortgage contract with the Hometown Bank and abstract all pertinent information that might be needed for
a financial disclosure.

Required:
(1) List the information in a mortgage that is likely to be relevant to the auditor.
(2) What are the pros and cons of using a disclosure checklist for this task?

(1) The information in a mortgage that is likely to be relevant to the auditor includes the following:
1. The parties to the agreement
2. The effective date of the agreement
3. The amounts included in the agreement
4. The repayment schedule required by the agreement
5. The definition and terms of default
6. Prepayment options and penalties specified in the agreement
7. Assets pledged or encumbered by the agreement
8. Liquidity restrictions imposed by the agreement
9. Purchase restrictions imposed by the agreement
10. Operating restrictions imposed by the agreement
11. Requirements for audit reports or other types of reports on compliance with the agreement
12. The interest rate specified in the agreement
13. Any other requirements, limitations, or agreements specified in the document

(2) While a checklist helps remind the auditor of matters that should be considered for disclosure and provides
a convenient format for the documentation of evidence, there may be items that should be disclosed but that are
not covered by the audit firm’s checklist. The auditor, therefore, cannot blindly follow a checklist, but should
also use good audit judgment especially when there are unusual circumstances of which the users should be
aware. For example, what if Cosmo Technologies has a controlling interest in Hometown Bank? This would be
a related-party issue.
173. Final Analytical Procedures and Disclosures

When auditing Global Alliance Industries, Inc., the auditor performed extensive analytical procedures and
found the following:
(a) The commission expenses as a percentage of sales has stayed constant for several years, but has increased
significantly in the current year. However, commission rates have not changed.
(b) The rate of inventory turnover has steadily decreased for the past four years.
(c) The inventory as a percentage of current assets has steadily increased for the past four years.
(d) The number of days’ sales in accounts receivable has steadily increased for three years.
(e) The allowance for uncollectible accounts as a percentage of accounts receivable has steadily decreased for
three years.
(f) The absolute amounts of depreciation expense and depreciation expense as a percentage of gross fixed assets
are significantly smaller than in the preceding year.

REQUIRED:

(1) Evaluate the significance of not disclosing or adjusting these items, if material, in the fair presentation of
financial statements.

(2) When assessing disclosures, what criteria do auditors use?

(1)
a. The commission expense could be overstated during the current year or could have been understated during
each of the past several years. It is also possible that sales may have been understated during the current year or
could have been overstated in each of the past several years.
b. It is very possible that obsolete or unsalable inventory may be present and may require markdown to the
lower of cost or market.
c. When this item is combined with the potential high likelihood that obsolete or unsalable inventory may be
present, as mentioned previously, it make sense that inventory may have been maintained at a higher level than
is necessary for the company.
d. The collection of accounts receivable appears to be a problem. It is very possible that an adjustment
provision for uncollectible accounts may be necessary.
e. When combined with (d) above, the allowance for uncollectible accounts may be understated.
f. It is very likely that depreciation expenses may be understated for the year.

(2) When assessing disclosures, the auditor should have reasonable assurance that:
 Disclosed events and transactions have occurred and pertain to the entity
 All disclosures that should have been included are included
 The disclosures are understandable to users
 The information is disclosed accurately and at appropriate amounts
174. Analytical procedures

What is the purpose of using analytical review procedures in the final review stages of the audit?

Analytical review procedures are required in the concluding stages of the audit to serve as an analysis of last
resort for potential misstatements in the financial statements. The reading of financial statements while
considering the adequacy of evidence gathered in response to unusual or unexpected balances or relationships
identified in planning the audit or during the course of the audit is an important reason for the final review
stage. It is also possible that unusual or unexpected balances or relationships may not appear until the audit has
been performed and proposed adjusting entries have been made.

175. Management representation letters

Describe the purpose of the management representation letter.

The purposes of the management representation letter are:

· It reminds management of its responsibility for the financial statements.

· It confirms oral responses obtained by the auditor earlier in the audit and the continuing appropriateness of those responses.
· It reduces the possibility of misunderstanding concerning matters that are the subject of representations.

The letter is typed on the client's letterhead, addressed to the auditor and signed by the CEO and the CFO.
176. Management representation letters

Barrett Jennings, CPA, has prepared a letter of representation for the president and controller to sign. The
following items are contained in it:

(a) Inventory is fairly stated at the lower of cost or market and includes no obsolete items.
(b) All actual and contingent liabilities are properly included in the financial statements.
(c) All subsequent events, relevant to the financial statements, have been disclosed.

Required:

(1) Why is it desirable to have a letter of management representation letter from the client concerning these
matters when the evidence accumulated during the course of the audit is meant to verify the same information?

(2) How is the letter of management representation useful as audit evidence?

(3) What are several other types of information commonly included in the management representation letter?
(1) It is desirable to have a management representation letter in addition to the accumulated audit evidence to
impress upon management its responsibility for the representations in the financial statements and to formally
document the responses from the client to auditor inquiries about various aspects of the audit. It also helps
reduce the possibility of misunderstanding concerning matters that are the subject of representations.

(2) The management representation letter is not very useful as audit evidence since it is a written statement from
a nonindependent source. In effect, the client being audited makes certain representations related to the audit.

(3) Other types of information include:

1. Financial statements
< Management's acknowledgment of its responsibility for the fair presentation in the financial statements of
financial position, results of operations, and cash flows in conformity with generally accepted accounting
principles (GAAP).
< Management’s belief that the financial statements are fairly presented in conformity with generally
accepted accounting principles (GAAP).

2. Completeness of information
< Availability of all financial records and related data
< Completeness and availability of all minutes or meetings of stockholders, directors, and committees of
directors
< Absence of unrecorded transactions

3. Recognition, measurement, and disclosure

< Management’s belief that the effects of any uncorrected financial statement misstatements are immaterial
to the financial statements
< Information concerning fraud involving (1) management, (2) employees who have significant roles in
internal control, or (3) others where the fraud could have a material effect on the financial statements
< Information concerning related party transactions and amounts receivable from or payable to related
parties
< Unasserted claims or assessments that the entity’s lawyer has advised are probable of assertion and must
be disclosed in accordance with FASB standards
< Satisfactory title to assets, liens or encumbrances on assets, and assets pledged as collateral
< Compliance with aspects of contractual agreements that may affect the financial statements

4. Subsequent events
< Bankruptcy of a major customer with an outstanding account receivable at the balance sheet date
< A merger or acquisition after the balance sheet date

5. Internal controls
< Management’s acknowledgement of its responsibility for establishing and maintaining effective internal
controls over financial reporting.
< Management’s conclusion about the effectiveness of internal control over financial reporting as of the end
of the fiscal period.
< Disclosure to the auditor of all deficiencies in the design or operation of internal control over financial
reporting identified as part of management’s assessment, including separate disclosure of significant
deficiencies and material weaknesses.
< Management’s knowledge of any material fraud or other involving senior management or other employees
who have a significant role in the company’s internal control over financial reporting.
177. Subsequent events

What are the two types of subsequent events identified in the accounting literature and what is required when
each occurs? Provide an example of each type of subsequent event.

The two types of subsequent events are Type I and Type II events. Type I subsequent events provide evidence
about conditions that existed at the balance sheet date. The financial statements should be adjusted to reflect this
type of subsequent event. Type II subsequent event indicates conditions that did not exist at the balance sheet
date. The financial statements should not be adjusted for these events, but they should be considered for
disclosure.

An example of a Type I subsequent event is a lawsuit that occurred before the balance sheet date that the client
had accrued a loss for as of year-end, but which was settled in early January for a much larger sum of money.
The client would have to accrue as of year-end the additional loss from the settlement of the lawsuit.

An example of a Type II subsequent event is where a natural disaster occurs after year-end in early January and
destroys a major warehouse or significant asset of the client. If the loss is material enough then the client will
need to disclose it in the notes to the financial statements but would not have to accrue it since the event does
not reflect conditions existing as of year-end.

178. Testing subsequent events

List the audit procedures to be performed to determine if subsequent events have occurred and have been
appropriately addressed.

The audit procedures performed when testing for subsequent events would include:

· Read the minutes of the meetings of the board of directors, stockholders, and other authoritative groups.
· Read interim financial statements and compare them to the audited financial statements, noting significant changes. Investigate significant
changes.
· Inquire of management concerning:
- any significant changes noted in the interim statements
- the existence of significant contingent liabilities or commitments at the balance sheet date or
date of inquiry
- any significant changes in working capital, long-term debt, or owners' equity
- the current status of items for which tentative conclusions were drawn earlier
- any unusual adjustments made to the records after year-end.
· Inquire of management and its legal counsel concerning contingencies.
· Obtain a management representation letter.
179. Type I subsequent events

Provide two examples of a Type I subsequent event and explain how these events would be treated in the
financial statements.

The instructor must review the student's responses, as they may vary.
Examples may include, but are not exclusive to:

1. Large customers who file for bankruptcy.

2. Settled contingencies and other liabilities.
3. Disposal of material property or equipment for a significant loss.

Type I subsequent events reflect conditions existing as of the balance sheet date. All of the above require adjustments to estimates before the
financial statements are finalized.

180. Type II subsequent events

Provide two examples of a Type II subsequent event and explain how these events would be treated in the
financial statements.

The instructor must review the student's responses, as they may vary.
Examples may include, but are not exclusive to:

1. Significant unrealized losses on securities held as investments.

2. Issuance of stocks, options, warrants and/or bonds.
3. Acquisition of subsidiary.
4. Public offering.
5. Entering into material agreements.
6. Uninsured loss of significant assets.

Type II subsequent events do not reflect conditions existing as of the balance sheet date and so do not require adjustment but may require disclosure
in the financial statements.
181. Dual-dating opinions

Describe the concept and the purpose of dual-dating an audit report.

Dual-dating the audit report reduces the auditor's responsibility. In normal situations, the auditor takes
responsibility for all events up to the report release date. The auditor is responsible only for events that occurred
after this date for which he or she has knowledge. If the auditor becomes aware of a subsequent event after the
this date that requires adjustment or discloser then the auditor may either use the date of the subsequent event as
the date of the audit report or the auditor may dual-date the report using the original report release date and the
date of the subsequent event.

The advantage of dual dating the audit report is that the auditor limits their responsibility. The date for
everything other than the subsequent event is the original report release date. The alternative is to date the audit
report as of the subsequent event. In that case the auditor has to extend their procedures up to the later date in
providing assurance that subsequent events have been appropriately adjusted or disclosed.
182. Engagement Quality Review

Morgan Thompson, CPA is a partner in a medium-sized CPA firm and takes an active part in the conduct of
every audit she supervises. She follows the practice of reviewing all audit files of staff auditors on her team as
soon as it is convenient, rather than waiting until the end of the audit. When the audit is nearly finished,
Thompson reviews the audit files again to make sure that she has not missed anything significant. Because she
makes most of the major decisions on the audit, there is rarely anything that requires further
investigation. When she completes the review, she prepares a draft of the financial statements, gets them
approved by management, and has them assembled in her firm’s office. No other partner reviews the audit
documentation, because Thompson is responsible for signing the audit reports.

REQUIRED:

(1) Evaluate the practice of not having a concurring partner review of the audit documentation by another
partner in the firm, (2) explain some of the procedures the reviewer should perform as part of the review
process, and (3) what documentation should be included.

(1) By not having a review of the audit documentation by another partner in the firm, there is no check against
any bias and unintentional error that may exist on the part of the auditor. An independent review is essential in
this case. Such a review is required for public company audits.

(2) Some of the procedures the reviewer should perform as part of the review process include:
 Discussing with the audit team any significant matters related to the financial statements and internal
controls, including the audit team’s identification of material weaknesses and audit procedures to address
significant risks
 Evaluating judgments about materiality and the disposition of corrected and uncorrected identified
misstatements
 Reviewing the engagement team’s evaluation of the firm’s independence in relation to the engagement
 Reviewing the related audit documentation to determine its sufficiency
 Reading the financial statements, management’s report on internal control, and auditor’s report
 Confirming with the lead audit partner that there are no significant unresolved matters
 Determining if appropriate consultations have taken place on difficult or contentious matters
 Evaluating whether the auditor documentation supports the conclusions reached by the engagement team
with respect to the matters reviewed
 Assessing whether appropriate matters have been communicated to audit committee members,
management, and other appropriate parties
 Evaluating whether appropriate levels of supervision and reviews of individual audit tasks were completed
adequately during the audit

(3) The audit documentation should include evidence on the performance of the engagement quality review.
This documentation should include the following information:

 Who performed the engagement quality review

 Documents reviewed by the engagement quality reviewer
 Date the engagement quality reviewer provided concurring approval of issuance
183. Management letters to clients

What is a management letter and how does it differ from a management representation letter?

The management letter is a letter from the auditor to the client about the auditor's observations of management
weaknesses. The management letter is not required. Its purpose is to provide useful advice and information to
the client so as to improve their operations. Many of the observations likely will relate directly to control
deficiencies or operational matters.

184. Client Acceptance

Newburg Company is in an industry in the early development stage, where there are minimal barriers to entry to
the client’s business model. Newburg Company’s audit committee decided to put their 2014 audit out for
bids. One of the Big Four CPA firms had performed their audits from 2011-2013, and although happy with the
previous auditor, the audit committee believed they should rotate to another firm. On the last audit, the Big
Four’s audit fees were $500,000. Barnaby, CPAs, came in as the low bidder, making a proposal to Newburg
Company regarding audit fees for 2014. Their proposed audit fee was $250,000.

Required:

(1) Based on this scenario, describe the ethical decisions that an auditor must make during portfolio
management decisions such as the client acceptance and client continuance decision. What is the relationship
between ethics and high audit quality?

(2) What issues should the client’s audit committee consider before going with the lowest bid?

(1) The ethical decisions that come into play during client acceptance and client continuance decisions concern
the trade-off between audit fees, resulting audit effort, and the ability to conduct a quality audit. Given the fee
data, one has to wonder whether Barnaby is going to do a quality audit in the year of the transition. Is it possible
to do a similar quality audit with half the resources? Perhaps the cost structure of Barnaby is much different
than that of the Big Four firm. If Barnaby has lower fixed and overhead costs, and lower litigation reserves, then
perhaps they can still earn the same relative profit on the engagement that the Big Four firm did. Perhaps, the
first year is considered a loss leader, as they gain experience with this new client. If not, then one must call into
question whether the audit effort applied by the two audit firms was roughly equivalent. Since audit hours are
not publicly disclosed, it is difficult to make a final determination. Ultimately, the ethical question is this: can
an audit firm do a quality job with the audit fee that they are charging? And do they have the relative expertise
necessary to make good audit judgments? If the answers to these questions is no, then there may be ethical
problems in the acceptance or continuance of a relationship with a client.

(2) The quality of an audit helps ensure the financial integrity of the company’s financial health and protects
assets, creditors and investors. Therefore, the audit committee should not approach this situation lightly. The
decision regarding an audit firms with a strong culture of quality places greater emphasis on developing,
maintaining, and monitoring systems of internal control that yield good decisions in this regard. The cheapest
deal may not always be the best deal, particularly in the area of quality.