Auditing theory and practice exam

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ACCT 422 – Auditing Theory and Practice

Final Exam

Due: 4 hours after Private Message containing exam is opened and no

later than Sunday, March 9, 2014 at 11:00 p.m. EST

Instructions: You have four (4) hours to complete and submit this final exam in your

assignment folder. This is an open book, open notes exam. This final exam consists of 3

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

“Final” 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: Multiple Choice questions – (worth total of 75 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.

Insurance expense for the period is a function of which of the following?

A. The beginning prepaid balance, current premium payments and the ending prepaid

balance.

B. The beginning prepaid balance and the current period premium payments.

C. The current period premium payments.

D. The current period premium payments and the ending prepaid balance.

2.

A significant customer of the firm suffers a large economic loss after year end, but

prior to completion of field work. The audit client believes this event will have material

effect on the financial statements. The auditor should:

A. adjust the financial statements for the year under audit.

B. add a paragraph to the audit report.

C. advise the client to disclose the event in the notes to the financial statements.

D. advise the client to delay issuing the financial statements until the economic loss

can be determined.

3.

Which of the following statements is true?

A. There is an inverse relationship between the interest and dividends accounts and

debt and equity.

B. There is no relationship between the interest and dividends accounts and debt and

equity.

C. There is a direct relationship between the interest and dividends accounts and debt

and equity.

D. None of the above is true.

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4.

The process of transferring money from one bank account to another and improperly

recording the transaction is referred to as:

A. kiting.

B. lapping.

C. scamming.

D. embezzling.

5.

Which of the following is least likely to uncover fraud?

A. External auditors

B. Internal auditors

C. Internal controls

D. Management

6.

Which of the following is not correct regarding an auditor's decision that a lower

acceptable audit risk is appropriate?

A. More evidence is accumulated.

B. Less evidence is accumulated.

C. Special care is required in assigning experienced staff.

D. Review of audit documentation is performed by personnel not assigned to the

engagement.

7.

An auditor is using audit sampling to test transactions in the acquisition and payment

cycle. She would normally set the tolerable exception rate at what level?

A. low

B. medium

C. high

D. indeterminate

8.

What are the two major balance-related audit objectives in testing payroll liabilities?

A. Accuracy and detail tie-in

B. Completeness and valuation

C. Completeness and rights and obligations

D. Accuracy and cutoff

9.

Which of the following audit tests both have the effect of simultaneously verifying

balance sheet and income statement accounts?

A. Analytical procedures and substantive tests of transactions

B. Tests of controls and substantive tests of transactions

C. Tests of details of balances and substantive tests of transactions

D. Tests of controls and analytical procedures

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10.

Who is generally responsible for opening receipts when a company uses a lockbox to

speed the handling of cash receipts?

A. company personnel

B. temporary employees in the town where the lockbox is located

C. bank employees

D. company controller

11.

Audit contracts (engagement letters):

A. may be either oral or written.

B. must be written.

C. must be written and notarized.

D. must be written if the client is regulated by the Securities and Exchange

Commission.

12.

Which of the following is not a characteristic of the reliability of evidence?

A. effectiveness of client internal controls

B. education of auditor

C. independence of information provider

D. timeliness

13.

In "auditing" financial accounting data, the primary concern is with:

A. determining whether recorded information properly reflects the economic events

that occurred during the accounting period.

B. determining if fraud has occurred.

C. determining if taxable income has been calculated correctly.

D. analyzing the financial information to be sure that it complies with government

requirements.

14.

The auditor's responsibility for "reviewing the subsequent events" of a public company

that is about to issue new securities is normally limited to the period of time:

A. beginning with the balance sheet date and ending with the date of the auditor's

report.

B. beginning with the start of the fiscal year under audit and ending with the balance

sheet date.

C. beginning with the start of the fiscal year under audit and ending with the date of

the auditor's report.

D. beginning with the balance sheet date and ending with the date the registration

statement becomes effective.

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15.

When conducting the audit of stockholders' equity it is normal practice to verify all

capital stock transactions:

A. only when the client is small.

B. that are in excess of a material amount.

C. if there aren't very many during the year.

D. regardless of the controls in existence, because of their materiality and permanence

in the records.

16.

When allocating materiality, most practitioners choose to allocate to:

A. the income statement accounts because they are more important.

B. the balance sheet accounts because there are fewer.

C. both balance sheet and income statement accounts because there could be errors on

either.

D. all of the financial statements because it is required by GAAS.

17.

Listed below are four interbank cash transfers, indicated by the numbers 1, 2, 3, and 4,

of a client for late December 2007 and early January 2008:

Bank Account One

Disbursing Date

(Month/Day)

Per Bank Per Books

1. 12/31 12/30

2. 1/2 12/30

3. 1/3 12/31

4. 1/3 12/31

Bank Account Two

Receiving Date

(Month/Day)

Per Bank Per Books

12/31 12/30

12/31 12/31

1/2 1/2

1/2 12/31

Based on the schedule of interbank transfers above, which of the cash transfers would

appear as a deposit in transit on the December 31, 2007 bank reconciliation?

A. 1

B. 2

C. 3

D. 4

18.

Internal controls normally include procedures designed to provide reasonable assurance

that:

A. employees act with integrity when performing their assigned tasks.

B. transactions are executed in accordance with management's authorization.

C. decision processes leading to management's authorization of transactions are sound.

D. collusive activities would be detected by segregation of employee duties.

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19.

When planning the audit, if the auditor has no reason to believe that illegal acts exist,

the auditor should:

A. include audit procedures which have a strong probability of detecting illegal acts.

B. still include some audit procedures designed specifically to uncover illegalities.

C. ignore the issue.

D. make inquiries of management regarding their policies for detecting and preventing

illegal acts and regarding their knowledge of violations, and then rely on normal

audit procedures to detect errors, irregularities, and illegalities.

20.

If a potential loss on a contingent liability is remote, the liability usually is:

A. disclosed in footnotes, but not accrued.

B. neither accrued nor disclosed in footnotes.

C. accrued and indicated in the body of the financial statements.

D. disclosed in the auditor's report but not disclosed on the financial statements.

21.

When the auditor has completed the tests of details of balances and enters phase 4 of

the audit process, she must still perform audit procedures for which of the following?

A. contingent liabilities and employee compensation

B. contingent liabilities and subsequent events

C. subsequent events and contractual commitments

D. subsequent events and unrecorded liabilities

22.

Which of the following statements is true as it relates to limited liability partnerships?

A. Only senior partners are liable for the partnership's debts.

B. Partners have no liability in a limited liability partnership arrangement.

C. Partners are personally liable for the acts of those under their supervision.

D. All partners must be AICPA members.

23.

Which of the following is the most efficient audit procedure for the detection of

unrecorded liabilities at the balance sheet date?

A. obtain an attorney's letter from the client's attorney

B. confirm large accounts payable balances at the balance sheet date

C. examine purchase orders issued for several days prior to the close of the year

D. compare cash disbursements in the subsequent period with the accounts payable

trial balance at year-end

24.

Because cash is the most desirable asset for people to steal, it has a higher:

A. control risk.

B. inherent risk.

C. detection risk.

D. liquidity risk.

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25.

Which of the following is not an objective of the auditor's examination of notes

payable?

A. To determine whether internal controls are adequate.

B. To determine whether client's financing arrangements are effective and efficient.

C. To determine whether transactions regarding the principal and interest of notes are

properly authorized.

D. To determine whether the liability for notes and related interest expense and

accrued liabilities are properly stated.

26.

Auditors need to distinguish between accounts payable and accrued liabilities in

designing the appropriate control and substantive tests. A liability is properly

accounted for as an account payable if:

A. the amount is known and owed as of the balance sheet date.

B. the amount can be estimated and is owed at the balance sheet date.

C. the amount is known at the balance sheet date and owed by the end of the next

fiscal year.

D. the amount is estimated and owed within 90 days of the balance sheet date.

27.

Normally it may be unnecessary to examine supporting documentation for each

addition to property, plant, and equipment, but it would be customary to verify:

A. all large transactions.

B. all unusual transactions.

C. a representative sample of typical additions.

D. all three of the above.

28.

Which of the following is a substantive test of transactions?

A. Review personnel policies.

B. Account for a sequence of payroll checks.

C. Reconcile the disbursements in the payroll journal with the disbursements on the

payroll bank statement.

D. Examine printouts of transactions rejected by the computer as having invalid

employee IDs.

29.

Audit procedures designed to uncover credit sales made after the client's fiscal year end

that relate to the current year being audited provide evidence for which of the following

audit objective?

A. realizable value

B. accuracy

C. cutoff

D. existence

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30.

CPAs may provide bookkeeping services to their non-public audit clients, but there are

a number of conditions that must be met if the auditor is to maintain independence.

Which of the following conditions is not necessary?

A. The CPA must not assume a management role or function.

B. The client must hire an external CPA to approve all of the journal entries prepared

by the auditor.

C. The auditor must comply with GAAS when auditing work prepared by his/her firm.

D. The client must accept responsibility for the financial statements.

31.

When a company maintains its own records of stock transactions and outstanding

stock, internal controls must be adequate to ensure that:

A. actual owners are recorded in the bylaws.

B. the correct amount of dividends is paid to stockholders owning the stock on the

dividend record date.

C. the correct amount of dividends is paid to stockholders owning the stock on the

declaration date.

D. actual owners are recorded in the minutes.

32.

Auditors tests of the client's bank reconciliation is done to verify whether the client's

recorded bank balance is the same amount as the actual cash in the bank. Which of the

following would not explain a difference between the company's cash balance and the

bank's balance for the client?

A. Deposits in transit

B. Cash collected on a Note Receivable by the bank

C. Other reconciling items

D. Outstanding checks

33.

When a client will not permit inquiry of outside legal counsel, the audit report will

ordinarily contain a(n):

A. disclaimer of opinion.

B. qualified opinion.

C. standard unqualified opinion.

D. unqualified opinion with a separate explanatory paragraph.

34.

A surprise payroll payoff in which employees must pick-up and sign for their pay

check is one means of:

A. identifying employees who do not have proper work credentials.

B. establishing a tightly controlled, fraud-free work environment.

C. testing for nonexistent employees.

D. identifying employees who have not submitted proper W-2 forms.

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35.

The auditor is performing tests of transactions for individual accounts payable

transactions with vendors. Which document provides more reliable information about

individual transactions with vendors?

A. Receiving report

B. Vendors Invoices

C. Vendor Statements

D. Purchase Orders

36.

Which balance-related audit objective is not relevant to an audit of prepaid expenses?

A. Rights

B. Accuracy

C. Detail tie-in

D. Realizable value

37.

Which of the following statements related to application controls is correct?

A. Application controls relate to various aspects of the IT function including software

acquisition and the processing of transactions.

B. Application controls relate to various aspects of the IT function including physical

security and the processing of transactions in various cycles.

C. Application controls relate to all aspects of the IT function.

D. Application controls relate to the processing of individual transactions.

38.

Brown Co.'s financial statements adequately disclose uncertainties that concern future

events, the outcome of which are not reasonably estimable. The auditor's report should

be a(n):

A. unqualified opinion.

B. disclaimer.

C. qualified opinion.

D. adverse opinion.

39.

The main focus taken by the auditor in verifying liability balances is on the discovery

of:

A. understated liabilities.

B. overstated liabilities.

C. extraneous liabilities.

D. overstated or extraneous liabilities.

40.

Which of the following is a major balance-related audit objective in testing payroll

liabilities?

A. Payroll tax expense is properly recorded.

B. Transactions in the payroll and personnel cycle are recorded in the proper period.

C. Accrual of salaries is the same as the amounts paid on the payroll tax returns.

D. Time records are recorded by supervisors.

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Part 2: (worth total of 10 points)

The fieldwork for the December 31, 2010 audit of Smith and Johnson Corporation

ended on March 15, 2011. The financial statements and auditor's report were issued

and mailed to shareholders on March 27, 2011. In each of the material situations (41

through 45) below, indicate the appropriate action (a, b, c, d, or e). The possible actions

are as follows:

a. Adjust the December 31, 2010 financial statements.

b. Disclose the information in a footnote in the December 31, 2010 financial

statements.

c. Request the client revise and reissue the December 31, 2010 financial statements.

The revision should involve an adjustment to the December 31, 2010 financial

statements.

d. Request the client revise and reissue the December 31, 2010 financial statements.

The revision should involve the addition of a footnote, but no adjustment, to the

December 31, 2010 financial statements.

e. No action is required.

The situations are as follows:

________ 41. On February 4, 2011, you discovered an uninsured lawsuit against Smith

and Johnson that had originated on August 28, 2010.

________ 42. On April 5, 2011, you discovered that a debtor of Smith and Johnson

went bankrupt on January 20, 2011, due to a major uninsured fire that occurred on

January 4, 2011.

________ 43. On January 18, 2011, a lawsuit was filed against Smith and Johnson for

a patent infringement action that allegedly took place in early 2008. In the opinion of

Smith and Johnson 's attorneys, there is a reasonable (but not probable) danger of a

significant loss to Smith and Johnson.

________ 44. On February 28, 2011, Smith and Johnson settled a lawsuit out of court

that had originated in 2005 and is currently listed as a contingent liability.

________ 45. On March 29, 2011, Smith and Johnson settled a lawsuit out of court that

had originated in 2007 and is currently listed as a contingent liability.

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Part 3: Short Answer/Short Essay questions - (worth total of 15 points)

Please provide responses to the following FIVE (5) discussion questions. The responses should

be numbered 46 – 50. Each response is worth 3 points for a total of 15 points.

46.

An environmental clean-up lawsuit is pending against your client. What information

about the lawsuit would you as the auditor need in order to determine the "correct"

accounting?

47.

Discuss three important differences between the payroll and personnel cycle and other

cycles in a typical audit.

48.

Explain the purpose of testing the client's bank reconciliation, and discuss the major

audit procedures involved.

49.

State the four most important audit objectives for capital stock and describe how the

auditor typically verifies each of the four objectives.

50. State the two primary types of subsequent events that require consideration by

management and evaluation by the auditor, and give two examples of each type.