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ACCT 422 – Auditing Theory and Practice
Exam #1
Due: 4 hours after the Private Message containing the Exam is opened
and no later than Sunday, February 2, 2014 at 11:00 p.m. EST
Instructions: You have four (4) hours to complete and submit this Exam in your assignment
folder. This is an open book, open notes Exam, however you should work independently. This
Exam consists of 4 parts. Your answers to the Exam should be submitted on a separate answer
sheet. Your answer sheet should be submitted as an attachment in your assignment folder under
the “Exam 1” folder in Microsoft Word, WordPerfect or PDF format. Please write your name
on your answer sheet. Please do not write your answers directly in the narrative portion of
your assignment folder.
Part 1: (worth total of 64 points)
For Part 1, please number your answer sheet from 1 to 40 and provide the letter corresponding to
the best answer (eg, 1. A, 2. B, etc.).
1.
Whenever an auditor issues an audit report for a public company, the auditor
can choose to issue a report in which of the following forms?
I. A combined report on financial statements and internal control over
financial reporting
II. Separate reports on financial statements and internal control over financial
reporting
A. I only
B. II only
C. Either I or II.
D. Neither I nor II.
2.
Which of the following audits can be regarded as generally being a compliance
audit?
A. A CPA firm's audit of a public company
B. GAO auditor's evaluation of the computer operations of governmental units
C. An internal auditor's review of a company's payroll authorization procedures
D. IRS agents' examinations of taxpayer returns
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3.
The provisions of the Sarbanes-Oxley Act of 2002 are most likely to allow
which of the following non-audit services for audit clients?
A. Appraisal or valuation services (e.g., pension, post-employment benefit
liabilities)
B. Financial information systems design and implementation
C. Tax consulting
D. Internal audit outsourcing
4.
Under the Securities Act of 1933, the auditor's responsibility for making sure
the financial statements were fairly stated extends to:
A. the date the registration statement becomes effective.
B. the date of the financial statements.
C. the date of the audit report.
D. one year beyond the date of the financial statements.
5.
All of the following are causes for the addition of an explanatory paragraph
under both AICPA and PCAOB standards except for:
A. emphasis of a matter.
B. reports involving other auditors.
C. lack of consistent application of generally accepted accounting principles.
D. auditor agrees with a departure from promulgated accounting principles.
6.
In describing the cycle approach to segmenting an audit, which of the following
statements is not true?
A. All general ledger accounts and journals are included at least once.
B. Some journals and general ledger accounts are included in more than one
cycle.
C. The "capital acquisition and repayment" cycle is closely related to the
"acquisition of goods and services and payment" cycle.
D. The "inventory and warehousing" cycle may be audited at any time during
the engagement since it is unrelated to the other cycles.
7.
When assessing the risk of material misstatements in the financial statements,
A. the auditor must have an understanding of the client's business and industry
B. GAAS specifies in detail how much and what types of evidence the auditor
needs to obtain.
C. company management is responsible for determining materiality levels.
D. inadequate internal control procedures will mitigate client business risk.
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8.
The trait that distinguishes auditors from accountants is the:
A. auditor's accumulation and interpretation of evidence related to a company's
financial statements.
B. auditor's education beyond the Bachelor's degree.
C. auditor's ability to interpret FASB Statements.
D. auditor's ability to interpret accounting principles generally accepted in the
United States.
9.
Gregory Williams, CPA, is the principal auditor for a multi-national
corporation. Another CPA has examined and reported on the financial
statements of a significant subsidiary of the corporation. Williams is satisfied
with the independence and professional reputation of the other auditor, as well
as the quality of the other auditor's examination. With respect to his report on
the consolidated financial statements, taken as a whole, Williams:
A. must not refer to the examination of the other auditor.
B. must refer to the examination of the other auditor.
C. may refer to the examination of the other auditor.
D. must refer to the examination of the other auditors along with the percentage
off consolidated assets and revenue that they audited.
10.
Which of the following statements about Generally Accepted Audit Standards
are true?
I. They serve as broad guidelines to auditors for conducting an audit
engagement.
II. They are sufficiently specific to provide any meaningful guide to
practitioners.
III. They represent a framework upon which the AICPA can provide
interpretations.
A. I and II
B. I and III
C. II and III
D. I, II and III
11.
In "auditing" financial accounting data, the primary concern is with:
A. analyzing the financial information to be sure that it complies with
government requirements.
B. determining if fraud has occurred.
C. determining if taxable income has been calculated correctly.
D. determining whether recorded information properly reflects the economic
events that occurred during the accounting period.
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12.
Which of the following instances would impair a CPA's independence when
they have been retained as the auditor?
I. A charitable organization where the CPA serves as treasurer
II. A municipality where the CPA owns $250,000 of the $25 million
outstanding bonds of the municipality
III. A company that the CPA's investment club owns a 10% investment interest
A. I and II
B. I and III
C. II and III
D. I, II, and III
13.
Which of the following statements about the Securities Act of 1933 is not true?
A. A third party that purchased securities described in the registration
statement may sue the auditor for material misrepresentations or omissions
in the audited financial statements.
B. A third party user has the burden of proof that the auditor was either
negligent or fraudulent in doing the audit.
C. A third party user does not have the burden of proof that he/she relied on the
financial statements.
D. A third party user does not have the burden of proof that the loss was caused
by the misleading statements.
14.
If a short-term note payable is included in the accounts payable balance on the
financial statement, there is a violation of the:
A. completeness assertion.
B. existence assertion.
C. cutoff assertion.
D. classification assertion.
15.
An examination of part of an organization's procedures and methods for the
purpose of evaluating efficiency and effectiveness is what type of audit?
A. Operational audit
B. Compliance audit
C. Financial statement audit
D. Production audit
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16.
Which of the following is not an essential component of quality control?
A. Policies and procedures to ensure that the work performed by firm personnel
meet applicable professional standards
B. Policies and procedures to ensure that firm personnel are actively engaged in
marketing strategies
C. Policies to ensure that personnel maintain their independence in fact and in
appearance
D. Policies that ensure that monitoring activities are effectively applied
17.
Under the AICPA independence rules, independence can be considered
impaired when:
A. when there is a lawsuit by the client claiming deficiencies in the previous
year's audit.
B. a client in bankruptcy has unpaid fees for more than one year.
C. there is litigation by the client related to the auditor's tax or other nonaudit
services.
D. billed fees remain unpaid for professional services for more than ninety
days.
18.
The auditor is determining that the correct selling price was used for billing and
that the quantity of goods shipped was the same as the quantity billed. She is
gathering evidence about which transaction related audit objective?
A. Existence
B. Accuracy
C. Completeness
D. Cut-off
19.
Under the Securities Act of 1933:
A. any party who relies on the company's audited financial statements can
recover from the auditors.
B. third-party users must prove that the auditor was negligent.
C. the burden of proof is on the defendant.
D. auditors face potential legal exposure for information contained in the Form
10-Q.
20.
________ risk reflects the possibility that the information upon which the
business decision was made was inaccurate.
A. Client acceptance
B. Control
C. Business
D. Information
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21.
Indicate which changes would require an explanatory paragraph in the audit
report.
A.
A departure from GAAP
which, due to unusual
circumstances, does not
require a qualified or adverse
opinion.
The CPA makes reference to
the work of another auditor
to indicate shared
responsibility in an
unqualified opinion.
Yes Yes
B.
A departure from GAAP
which, due to unusual
circumstances, does not
require a qualified or adverse
opinion.
The CPA makes reference to
the work of another auditor
to indicate shared
responsibility in an
unqualified opinion.
No No
C.
A departure from GAAP
which, due to unusual
circumstances, does not
require a qualified or adverse
opinion.
The CPA makes reference to
the work of another auditor
to indicate shared
responsibility in an
unqualified opinion.
Yes No
D.
A departure from GAAP
which, due to unusual
circumstances, does not
require a qualified or adverse
opinion.
The CPA makes reference to
the work of another auditor
to indicate shared
responsibility in an
unqualified opinion.
No Yes
22.
When the auditor determines that the financial statements are fairly stated, but
there is a nonindependent relationship between the auditor and the client, the
auditor should issue:
A. an adverse opinion.
B. a disclaimer of opinion.
C. either a qualified opinion or an adverse opinion.
D. either a qualified opinion or an unqualified opinion with modified
wording.
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23.
Several months after an unqualified audit report was issued, the auditor
discovers the financial statements were materially misstated. The client's CEO
agrees that there are misstatements, but refuses to correct them. She claims that
"confidentiality" prevents the CPA from informing anyone. Which of the
following statements is correct?
A. The CEO is incorrect, and the auditor has an obligation to issue a revised
audit report, even if the CEO will not correct the financial statements.
B. The CEO is correct, but to be ethically correct, the auditor should violate the
confidentiality rule and disclose the error.
C. The CEO is incorrect, but since the audit report has been issued, it is too late
to correct the report.
D. The CEO is correct and the auditor must maintain confidentiality.
24.
Which of the following is a true statement regarding auditing standards?
A. Prior to the passage of Sarbanes-Oxley, the FASB established auditing
principles for U.S. public companies.
B. PCAOB auditing standards are applicable to entities outside the U.S.
C. There are no similarities between PCAOB standards and International
Standards on Auditing.
D. The Auditing Standards Board has revised most of its standards to converge
with the international standards.
25.
A CPA is subject to criminal liability if the CPA:
A. refuses to turn over requested audit documentation to a client.
B. performs an audit in a negligent manner.
C. is knowingly involved with false financial statements.
D. willfully breaches a contract with a client.
26.
If the auditor has obtained a reasonable level of assurance about the fair
presentation of the financial statements through understanding internal control,
assessing control risk, testing controls, and analytical procedures, then the
auditor:
A. can issue an unqualified opinion.
B. can write the engagement letter.
C. can significantly reduce other substantive tests.
D. needs to perform additional tests of controls so that the assurance level can
be increased.
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27.
If the board of accountancy in the state in which a CPA firm is licensed has
rules that are different than the AICPA's rules, the CPA firm must follow:
A. the rules of the AICPA.
B. the rules of the state's board of accountancy.
C. whichever rules are less restrictive.
D. whichever rules are more restrictive.
28.
When the client fails to make adequate disclosure in the body of the statements
or in the related footnotes, it is the responsibility of the auditor to:
A. present the information in the audit report and issue an unqualified or
qualified opinion.
B. present the information in the audit report and to issue a qualified or an
adverse opinion.
C. inform the reader that disclosure is not adequate, and to issue an adverse
opinion.
D. inform the reader that disclosure is not adequate, and to issue a qualified
opinion.
29.
Which of the following statements is not true?
A. Balance-related audit objectives are applied to ending account balances.
B. Transaction-related audit objectives are applied to classes of transactions.
C. Balance-related audit objectives are applied to the ending balance in balance
sheet accounts.
D. Balance-related audit objectives are applied to both beginning and ending
balances in balance sheet accounts.
30.
When a pervasive scope limitation exists:
A. a disclaimer of opinion rather than a qualified opinion is generally required.
B. the auditor's responsibility paragraph is modified to indicate that the auditor
was not able to obtain sufficient appropriate evidence to express an audit
opinion.
C. sections of the auditor's responsibility paragraph are eliminated to avoid
stating anything that might lead readers to believe that other parts of the
financial statements might be fairly stated.
D. all of the above.
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31.
The responsibility for the preparation of the financial statements and the
accompanying footnotes belongs to:
A. the auditor.
B. management.
C. both management and the auditor equally.
D. management for the statements and the auditor for the notes.
32.
To succeed in an action against the auditor, the client must be able to show that:
A. the auditor was fraudulent.
B. the auditor was grossly negligent.
C. there was a written contract.
D. there is a close causal connection between the auditor's behavior and the
damages suffered by the client.
33.
If the balance sheet of a private company is dated December 31, 2011, the audit
report is dated February 8, 2012, and both are released on February 15, 2012,
this indicates that the auditor has searched for subsequent events that occurred
up to:
A. December 31, 2011.
B. January 1, 2012.
C. February 8, 2012.
D. February 15, 2012.
34.
Which of the following statements is true when the CPA has been engaged to
perform an audit of financial statements?
A. The CPA firm is engaged and paid by the client; therefore, the firm has
primary responsibility to be an advocate for the client.
B. The CPA firm is engaged and paid by the client, but the primary
beneficiaries of the audit are those who rely on the financial statements.
C. Should a situation arise where there is no convincing authoritative standard
available, and there is a choice of actions which could impact a client's
financial statements, the CPA is free to endorse the choice which is in the
investors' interests.
D. The CPA firm has primary responsibility to the FASB.
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35.
Sarbanes-Oxley and the Securities Exchange Commission restrict auditors from
providing many consulting services to their publicly traded audit clients. Which
of the following is true for auditors of publicly traded companies?
I. They are restricted from providing consulting services to privately held
companies.
II. There is no restriction on providing consulting services to non-audit clients.
A. I only
B. II only
C. I and II
D. Neither I or II
36.
In comparing management fraud with employee fraud, the auditor's risk of
failing to discover the fraud is:
A. greater for management fraud because managers are inherently more
deceptive than employees.
B. greater for management fraud because of management's ability to override
existing internal controls.
C. greater for employee fraud because of the higher crime rate among blue
collar workers.
D. greater for employee fraud because of the larger number of employees in the
organization.
37.
Which of the auditor's defenses is ordinarily not available when lawsuits are
filed by a third party?
A. Contributory negligence
B. Absence of causal connections
C. Non-negligent performance
D. Lack of duty
38.
According to the Principles section of the Code of Professional Conduct, all
members:
A. should be independent in fact and in appearance at all times.
B. in public practice should be independent in fact and in appearance at all
times.
C. in public practice should be independent in fact and in appearance when
providing auditing, tax, and other attestation services.
D. in public practice should be independent in fact and in appearance when
providing auditing and other attestations services.
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39.
Which of the following are required to have a written report regarding the
assertion of another party?
A.
Financial
Statement
Audit
Operational
Audit
Compliance
Audit
Attestation
Engagement
Assurance
Engagement
Y Y Y Y Y
B.
Financial
Statement
Audit
Operational
Audit
Compliance
Audit
Attestation
Engagement
Assurance
Engagement
Y Y Y N N
C.
Financial
Statement
Audit
Operational
Audit
Compliance
Audit
Attestation
Engagement
Assurance
Engagement
Y Y Y Y N
D.
Financial
Statement
Audit
Operational
Audit
Compliance
Audit
Attestation
Engagement
Assurance
Engagement
N N N Y Y
40.
If an auditor of a public company cannot find guidance issued by the PCAOB
on a particular audit matter, the auditor should generally seek guidance from
which of the following sources?
A. Regulations issued by the Securities and Exchange Commission
B. The AICPA Code of Professional Conduct
C. Statements on Auditing Standards
D. Statements on Standards for Accounting and Review Services
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Part 2: (worth total of 16 points)
For Part 2, please number your answer sheet from 41 to 50 and provide the letter corresponding
to the best answer (eg, 41. A, 42. B, etc.).
41. The primary purpose of a compliance audit is to determine whether the financial
statements are prepared in compliance with generally accepted accounting
principles.
A. True
B. False
42. All CPA firms registered with the PCAOB are required to undergo a peer
review annually.
A. True
B. False
43. An audit generally provides no assurance that illegal acts that do not have a
direct effect on the financial statements will be detected.
A. True
B. False
44. The same three defenses available to auditors in common lawsuits by third
parties nonnegligent performance, lack of duty, and absence of causal
connection–are also available for suits under the Securities Exchange Act of
1934.
A. True
B. False
45. Changes in reporting entities, such as the inclusion of an additional company in
combined financial statements, affect comparability but not consistency, and
therefore do not require an explanatory paragraph in the audit report.
A. True
B. False
46. Many litigation experts believe that a well written engagement letter
significantly reduces the likelihood of adverse legal actions.
A. True
B. False
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47. Auditing standards in the United States allow an auditor to perform an audit of a
U.S. entity in accordance with both generally accepted auditing standards in the
U.S. and the ISAs.
A. True
B. False
48. Information obtained by a CPA from a client is legally privileged in federal
court.
A. True
B. False
49. Quality controls are established for the entire CPA firm whereas GAAS are
applicable to the individual engagement.
A. True
B. False
50. For a private company audit, tests of controls are normally performed only on
those internal controls the auditor believes have not been operating effectively
during the period under audit.
A. True
B. False
Part 3: (worth total of 10 points)
Each of the following situations (51 – 55) involves a possible violation of the rule on
independence. For each situation, (a) decide whether the Code of Professional Conduct has been
violated, and (b) briefly explain how the situation violates (or does not violate) the Code of
Professional Conduct.
51. Henry Johnson is a partner in the Topeka office of Henderson & Co., CPAs. Henry's sister is
employed in an audit-sensitive position by Blueray Inc, a publicly held company in Kansas.
Blueray Inc is one of Henderson & Co.'s audit clients. Neither Henry nor personnel from the
Topeka office is involved in the audit of Blueray.
Violation? Yes No
Explanation:
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52. Jimmy Owens is an audit manager with Epiphany & Co., CPAs, a one-office CPA firm.
Jimmy owns 100 shares of common stock in one of the firm's audit clients, but he does not
provide any audit or non-audit services to the company.
Violation? Yes No
Explanation:
53. The accounting firm of Stein & Shugerman, CPAs, provides bookkeeping and tax services
for Hechinger Corporation, a privately held company. Stein & Shugerman also performs the
annual audit of Hechinger Corporation.
Violation? Yes No
Explanation:
54. Bill Shiefler CPA, is the auditor of Cafe Olay. A couple of weeks ago, Cafe Olay's
management commenced litigation against Bill, alleging he was negligent in last year's audit.
Violation? Yes No
Explanation:
55. Hill Appliances has not paid Kathy Lin, CPA, her audit fee for the past two years. Kathy is
starting work on the current year's audit of Hill Appliances.
Violation? Yes No
Explanation:
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Part 4: (worth total of 10 points)
The scenarios below (56 – 60) all involve a possible violation of the AICPA's Code of
Professional Conduct.
(i) Using the list below, indicate which of the Code of Conduct Rules applies to
the scenario.
a. 101: Independence
b. 102: Integrity and Objectivity
c. 302: Contingent Fees
d. 501: Acts Discreditable
e. 503: Commissions and Referral Fees
f. 505: Form of Organization and Name
(ii) State if the scenario is a violation of the Code and, if so, briefly explain why.
Scenario:
56. Johnson & Maxwell formed a successful CPA practice ten years ago. In the current year,
they approached Jack Samuel, a surgeon and medical expert, and asked him to assist them with
their growing medical consulting practice. Samuel agreed, but only after he was given an
ownership interest in the firm. Samuel does intend to reduce his private practice hours and spend
45% of his working hours devoted to the Johnson & Maxwell practice.
57. Michelle Bradley, CPA, was traveling from San Diego to Los Angeles when she was pulled
over by a police officer for suspicion of driving under the influence. She was convicted in court
of driving under the influence of alcohol and received six months probation.
58. Jason Alexander is an audit manager with Reese & Co., CPAs. Jason owns 100 shares of
common stock in one of the firm's audit clients, but he does not provide any audit or non-audit
services to the company.
59. Elaine Cooper CPA, is the auditor of Paula's Pizza. Toward the end of the audit, Paula gave
Elaine her estimate of receivable collectability and Elaine accepted it without any testing.
60. Charley Ray, CPA, is a member of the engagement team that performs the audit of Desiree
Corporation. Charley's five-year-old daughter, Becky, received ten shares of Desiree common
stock for her fifth birthday in a trust fund established by Becky's grandmother.
