ACC

476/726

Auditing

Sample Exam #1
Prof. Elder

Name:

Ivan D. Auditor

This exam contains 11 pages; please check to make sure you have the entire exam. You will have
one hour and twenty-five minutes to complete the exam. Total points available on the exam are as
follows:

Question

Points
Possible

Multiple choice - 20 at 3 pts. Each

60

Audit reports

12

Legal liability and ethics

Audit objectives and evidence

12

Analytical procedures and CPA services

Total points

Points
Earned

100

If you are unsure as to the nature of any question, please ask. Written responses should be as
complete as possible to ensure partial credit.
Good luck!

Multiple Choice -- 3 Points Each. Choose the one best response that you believe is most
appropriate. Write your response in the margin next to the question.
1.

An auditor most likely would analyze inventory turnover rates to obtain evidence concerning
management's assertions about:
a.
b.
c.
d.

2.

Existence or occurrence.
Valuation or allocation.
Rights and obligations.
Presentation and disclosure.

When the financial statements contain a material departure from GAAP, the auditor will
generally issue a(an), dependent on materiality of the item:
Qualified Scope
and opinion
a.
b.
c.
d.

3.

No
Yes
Yes
No

The primary reason for an audit by an independent, external CPA firm is:
a.
b.
c.
d.

4.

Yes
No
Yes
No

Adverse
opinion

To guarantee that there are no misstatements in the financial statements.

To ensure that any fraud will be discovered.
To lend credibility to the financial statements.
To relieve management of responsibility for the financial statements.

In using the work of a specialist, an auditor may refer to the work of the specialist in the
auditor's report if, as a result of the specialist's findings, the auditor:
a.
b.
c.
d.

Becomes aware of conditions causing substantial doubt about the entity's ability to
continue as a going concern.
Desires to disclose the specialist's findings, which imply that a more thorough audit
was performed.
Is able to corroborate another specialist's earlier findings that were consistent with
management's representations.
Discovers significant deficiencies in the design of the entity's internal control structure
that management does not correct.

5.

Under which of the following circumstances would a disclaimer of opinion not be

appropriate?
a.
b.
c.
d.

6.

After determining that a related party transaction has in fact occurred, an auditor should
a.
b.
c.
d.

7.

Perform analytical procedures to verify whether similar transactions occurred, but

were not recorded.
Substantiate that the transaction was consummated on terms equivalent to an arm's
length transaction.
Determine whether the nature of the transaction is properly disclosed.
Add a separate paragraph to the auditor's standard report to explain the transaction.

Which of the following presumptions is correct about the reliability of evidential matter?
a.
b.
c.
d.

8.

The auditor is unable to determine the amounts associated with an employee fraud
scheme.
Management does not provide reasonable justification for a change in accounting
principles.
The client refuses to let the auditor confirm certain accounts receivable or apply
alternative procedures to verify their balances.
The chief executive is unwilling to provide copies of the corporate minute books.

Evidence obtained indirectly from outside sources is the most reliable evidential
matter.
Analytical procedures are the most reliable form of evidence.
Reliability of evidential matter refers to the amount of corroborative evidence
obtained.
An effective internal control structure provides more assurance about the reliability of
evidential matter.

Which of the following tends to be most predictable for purposes of analytical procedures
used as substantive tests of evidence?
a.
b.
c.
d.

Expenses subject to non-controllable fluctuations.

Transactions subject to management discretion.
Relationships involving income statement accounts.
Relationships involving balance sheet accounts.

9.

Park, CPA was engaged to audit the financial statements of Tech Co., a new client, for the
year ended December 31, 2002. Park obtained sufficient evidence for all of Tech's financial
statement items except Tech's January 1, 2002 inventory balances, which are highly material.
Park's opinion on Tech's 2002 financial statements most likely will be
Balance Sheet
a.
b.
c.
d.

10.

Disclaimer
Unqualified
Disclaimer
Unqualified

Disclaimer
Disclaimer
Unqualified
Adverse

Analytical procedures can be performed in the planning phase, as a substantive test in the
testing phase, and in the completion stage of the audit. In which phases are analytical
procedures required?
Testing
Phase
a.
b.
c.
d.

11.

Statement of Cash Flows

Yes
No
Yes
No

Completion
Phase
Yes
No
No
Yes

Under the 1933 Securities Act, which of the following must be proven by the purchaser of
the security?
Reliance on the
Financial Statements
a.
b.
c.
d.

12.

Yes
Yes
No
No

Fraud by
the CPA
Yes
No
Yes
No

Which of the following events most likely indicates the existence of related parties?
a.
b.
c.
d.

Borrowing large sums of money at a variable rate of interest.

Selling real estate at a price that differs significantly from its book value.
Making a loan without scheduled terms for repayment of the funds.
Discussing merger terms with a company that is a major competitor.

13.

Under the Ultramares rule, to which of the following parties will an accountant be liable for
negligence?
Parties in privity
a.
b.
c.
d.

14.

Yes
No
No
Yes

a.
b.
c.
d.

Direct Effect
Indirect Effect
Illegal ActsIllegal Acts

Reasonable
Reasonable
None
Reasonable
Reasonable
Reasonable
Reasonable
None
None
Limited Limited
Negative

The auditor performs analytical procedures and discovers an unexplained decrease in the
gross margin percentage. A possible explanation for this is:
a.
b.
c.
d.

16.

Yes
No
Yes
No

What assurance does the auditor provide that fraud, direct effect illegal acts, and indirect
effect illegal acts that are material to the financial statements will be detected?
Fraud

15.

Foreseen parties

A change in the sales mix in the current year such that a greater percentage of unit
sales are high margin items.
Fictitious sales.
A decrease in the unit cost of producing goods which was not passed along to the
consumer.
Unrecorded sales.

In which of the following situations would an auditor normally choose between expressing an
"except for" qualified opinion or an adverse opinion?
a.
b.
c.
d.

The auditor did not observe the entity's physical inventory and is unable to become
satisfied by other auditing procedures.
The financial statements fail to disclose information that is required by generally
accepted accounting principles.
The entity changed its method of accounting for income taxes in accordance with a
new FASB statement.
Event's disclosed in the financial statements cause the auditor to have substantial
doubt about the entity's ability to continue as a going concern.

17.

Which of the following ultimately determines the specific audit procedures necessary to
provide an independent auditor with a reasonable basis for the expression of an opinion?
a.
b.
c.
d.
e.

18.

Which of the following accounts would most likely be reviewed by the auditor to gain
reasonable assurance that additions to the equipment account are not understated?
a.
b.
c.
d.

19.

Depreciation expense.
Gain on disposal of equipment.
Accounts payable.
Repairs and maintenance expense.

Which of the following is least likely to include a reference to the use of a specialist?
a.
b.
c.
d.

20.

The audit program.

Generally Accepted Auditing Standards.
The time budget and fee constraints.
The auditor's judgment.
The auditor's working papers.

Unqualified opinion.
Adverse opinion.
"Except for" qualified opinion.
Unqualified opinion with explanatory paragraph.

When the scope of the auditors examination has been limited, the auditor may generally issue
a(an): (dependent on materiality of the item)
Disclaimer of
opinion
a.
b.
c.
d.

Yes
Yes
No
No

Adverse
opinion
No
Yes
Yes
No

Problem 1 - Audit Reports (12 points)

Items 1 through 6 on the following page represent independent factual situations an auditor might
encounter in conducting an audit. List A represents the types of opinions the auditor would
ordinarily issue and List B represents the report modifications (if any) that would be necessary. For
each situation, select one response from List A and one from List B. Select as the best answers for
each item the action the auditor would normally take. The types of opinions in List A and the report
modifications in List B may be selected once, more than once, or not at all.
Assume:
The auditor is independent
The auditor expressed an unqualified opinion on the previous year's financial statements.
The conditions for an unqualified opinion exist unless contradicted by the factual situations.
The conditions in the factual situations are material.
Disclosures are adequate unless indicated otherwise.
No report modifications are necessary except as indicated by the factual situations. Emphasis of
a matter would not be used unless the facts indicate its necessity.
List A Types of Opinions

List B - Report Modifications

A. An unqualified opinion
B. An unqualified opinion with explanatory
paragraph
C. Either an adverse opinion or a disclaimer
of opinion.
D. Either a qualified opinion or adverse
opinion (depending on materiality of item)
E. Either a qualified scope and opinion or
disclaimer of opinion (depending on
materiality of item).

1. Describe the circumstances in an explanatory

paragraph preceding the opinion without
modifying the three standard paragraphs.
2. Describe the circumstances in an explanatory
paragraph following the opinion paragraph without
modifying the three standard paragraphs.
3. Describe the circumstances in an explanatory
paragraph preceding the opinion paragraph and
modify the opinion paragraph.
4. Describe the circumstances in an explanatory
paragraph following the opinion paragraph and
modify the opinion paragraph.
5. Describe the circumstances in an explanatory
paragraph preceding the opinion paragraph and
modify the scope and opinion paragraph.
6. Describe the circumstances in an explanatory
paragraph following the opinion paragraph and
modify the scope and opinion paragraph.
7. Describe the circumstances within the introduction,
scope and opinion paragraphs without adding an
explanatory paragraph.
8. Issue the standard auditor's report without
modification.

Problem 1 - Audit Reports (continued)

(1 point)
List A

(1 point)
List B

Situation

1.

The company is in the airline leasing business. During the year, they
changed depreciation methods, which resulted in a material increase
in depreciation expense. They also extended the useful lives of their
planes, which significantly decreased depreciation expense. The net
effect of these two changes was not material.

2.

An auditor hires an actuary to assist in corroborating the client's

complex pension calculations concerning accrued pension
liabilities. The actuary found that the client's pension accrual is
materially understated; the client is unwilling to increase the
accrual.

3.

A principal auditor is unwilling to take full responsibility for the

work of another CPA who audited a wholly-owned subsidiary of
the entity and issued an unqualified opinion. The total assets and
revenues of the subsidiary represent 17% and 18%, respectively, of
the total assets and revenues of the entity being audited.

4.

A client changes its method of accounting for inventories from

FIFO to LIFO. You agree with the change, which is fully
disclosed but has a material affect on the comparability of the
financial statements.

5.

The auditor was appointed after year-end and was unable to

observe the ending balances in inventory. The auditor was unable
to satisfy herself as to the inventory balance using alternative
procedures.

6.

The entity issues financial statements that present financial position

and results of operations, but omits the statement of cash flows.

Problem 2 - Legal Liability and Ethics (8 points)

Part a. - Legal Liability (4 points) - You were negligent in the performance of an audit. Indicate
whether you are likely to be found liable under the following liability regimes and level of negligence
(add explanation if considered necessary):
Auditor liable?
Degree of negligence

Yes

Gross negligence

Under common law, to a bank relying on the financial

statements. You were not aware that the bank would
use the financial statements.

Ordinary negligence

To shareholders of a publicly traded company

following the ruling embodied in the Hochfelder case
requiring "scienter."

Ordinary negligence

To the original investors in an initial public offering.

The investors did not rely on the misstated financial
statements in their decision to invest.

Ordinary negligence

Under the Ultramares Doctrine, to creditors relying

on the financial statements. You knew the financial
statements might be used by creditors, but did not
know the specific creditors.

No

Part b. - Ethics (4 points) The following questions represent possible violations of either SEC or
AICPA Professional Standards. Indicate whether these represent violations (4 points)
Violation?
Situation

Yes

1.

You have just been hired as a staff auditor in the Syracuse office of
CostFirehouse, CPA. You own 200 shares of WebScape, a hightech company audited by the San Jose office.

2.

Flintstone, CPA provides the audit and bookkeeping, tax and

management consulting services to Cogswell Cogs, a privately held
company.

3.

Rubble, CPA is the auditor for and provides information systems

consulting for Spacely Sprockets, a publicly held company.

4.

Simpkins is a staff person on the General Electric audit. He owns

10 shares of stock in General Electric that were given to him by his
grandmother.

No

Problem 3 - Audit Objectives and Evidence (12 points)

For each specific audit objective (audit procedure), identify the most appropriate audit objective and
8

the type of evidence. Select a lettered response from the first two columns for the audit objective,
and numbered response from the last column for the type of evidence. Indicate only one response
for each item. Lettered and numbered responses may be used more than once or not at all.
Selected Audit Objective
Transaction objectives
a. Occurrence
b. Completeness
c. Accuracy
d. Classification
e. Timing
f. Posting and summarization

Balance objectives
g. Existence
h. Completeness
i. Accuracy
j. Classification
k. Cutoff
l. Detail tie-in
m. Realizable value

Type of evidence
1. Physical examination
2. Confirmation
3. Documentation
4. Observation
5. Inquiries of client
6. Recalculation
7. Reperformance
8. Analytical procedures
(1 pt.)
Audit
Objective

1.

Determine if cash disbursement transactions are for

goods and services actually received.

2.

Determine whether prices for sales transactions agree with

the approved price list.

3.

Examine sales invoices recorded at year end to determine

if they are recorded in the proper period.

4.

Obtain a letter from the client indicating that all

existing accounts payable have been recorded.

5.

Add the purchases journal for the month of July and

trace to amounts recorded in the general ledger.

6.

Examine invoices recorded in repair and maintenance

account to determine if any should be capitalized.

7.

Add the fixed asset ledger and agree total to amount

on the year-end trial balance.

8.

Examine condition of inventory to determine if saleable.

(1/2 pt.)
Type of
Evidence

_____

Problem 4 - Analytical Procedures and CPA Services (8 points)

a.

Changes in ratios (2 points)

A company provides the following information:
2002

2001

Sales (millions)

181.1

128.2

Cost of Sales

94.9

70.8

Gross margin

47.6%

44.8%

Accounts receivable (millions)

51.0

27.8

AR turnover

3.6

4.6

Inventory (millions)

39.1

19.6

Inv. Turnover

2.4

3.6

1. Calculate the dollar amount of the change in gross margin. Show calculation. (1 point)

2. Calculate the dollar amount of the unexpected change in accounts receivable. Show
calculation. (1 point)

10

b.

Analytical procedures may be performed in the planning (begin.), during the audit, or at the end of
the audit. For each of the following procedures, indicate when it is most likely to be performed by
placing an "X" in the appropriate column. Choose only one answer. There is only one correct
answer for each question, and answers may be used once, more than once, or not at all (3 points).
Time of test in audit
Analytical procedure

Begin.

During

End

Review the financial statement for unusual

fluctuations not identified in other testing.
Compare client ratios to similar firms to learn more
about the client's industry.
Test the reasonableness of depreciation expense by
multiplying cost times the depreciation rate.

c. The following figure indicates services provided by CPA firms (3 points)

Services Provided by CPA Firms

d
a
b
Tax
Services

Match each letter from the figure with the following terms (1/2 pt each):
1. _________

Audit services

2. _________

Assurance services

3. _________

Accounting and bookkeeping services

4. _________

Attestation services

Which circle is currently increasing in importance? (circle) 1 point

Left

Right
Last page of exam

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