Chapter 2 Defining Professional Responsibility

Defining Professional Responsibility:

Quality Standards and Ethics
MULTIPLE CHOICE:
1.

Which of the following did not result at least partially due

to the alleged audit failures of the 1980s and 1990s?
a.
b.
c.
d.

The Treadway Report.

An SAS further defining the auditors responsibility
for fraud detection.
Formation of the AICPA Fraud Commission.
Formation of the Independence Standards Board.

ANSWER:
2.

3.

Competence as a certified public accountant includes all of

the following except
a.
Having the technical qualifications to perform an
engagement.
b.
Possessing the ability to supervise and evaluate the
quality of staff work.
c.
Warranting the infallibility of the work performed.
d.
Consulting others if additional technical information
is needed.
ANSWER: C
Which of the following is mandatory if the auditor is to
comply with generally accepted auditing standards?
a.
Possession by the auditor of adequate technical
training.
b.
Use of analytical review on audit engagements.
c.
Use of statistical sampling whenever feasible on an
audit engagement.
d.
Confirmation by the auditor of material accounts
receivable balances.
ANSWER:

4.

As a guidance for measuring the quality of the performance

of an auditor, the auditor should refer to
a.
Statements of the Financial Accounting Standards Board.
b.
Generally Accepted Auditing Standards.
c. Interpretations of the Statements on Auditing Standards.
d.
Statements on Quality Control Standards.

10

Chapter 2 Defining Professional Responsibility

ANSWER:

5.

In addition to auditing, CPAs perform other services for

their clients. Standards governing the quality of these
services are covered in the attestation standards generally,
and performance requirements are more explicitly defined in
sets of statements relating to each type of service. Which
of the following is not such a set?
a.
Statements on Standards for Consulting Services.
b.
Statements on Responsibilities in University Audits.
c.
Statements on Standards for Accounting and Review
Services.
d.
Statements on Responsibilities in Tax Practice.
ANSWER:

6.

Which of the following is a violation of Rule 301

(Confidential Client Information) of the Code of
Professional Conduct?
a.
The CPA, in response to a court subpoena, submits
auditor-prepared workpapers as evidence of possible
illegal acts perpetrated by the client.
b.
The CPA discloses to the board of directors a scheme
concocted by top management to intentionally inflate
earnings.
c.
The CPA warns Client B as to the inadvisability of
acquiring Client A. The CPA bases this warning on
knowledge of Client A's financial condition and a
belief that the management of Client A lacks integrity.
This knowledge was obtained by the CPA as a result of
auditing Client A during the past several years.
d.
The CPA, when questioned in court, admits to knowledge
of certain illegal acts perpetrated by the client.
ANSWER:

7.

Which of the following statements best describes why the

CPA profession has deemed it essential to promulgate
ethical standards and to establish means for ensuring their
observance?
a.
A requirement for a profession is the establishment
of ethical standards that stress primarily a
responsibility to clients and colleagues.
b.
A requirement of most state laws calls for the
profession to establish a code of ethics.
c.
An essential means of self-protection for the

Chapter 2 Defining Professional Responsibility

d.

profession is the establishment of flexible ethical

standards by the profession.
A distinguishing mark of a profession is its
acceptance of responsibility to the public.

ANSWER:
8.

11

Which of the following best describes what is meant by

generally accepted auditing standards?
a.
Audit objectives generally determined on audit
engagements.
b.
Acts to be performed by the auditor.
c.
Measures of the quality of the auditor's performance.
d.
Procedures to be used to gather evidence to support
financial statements.
ANSWER:

9. Which of the following best describes what is meant by

generally accepted auditing standards?
a.
Pronouncements issued by the Auditing Standards Board.
b.
Procedures to be used to gather evidence to support
financial statements.
c.
Rules acknowledged by the accounting profession because
of their universal compliance.
d.
Measures of the quality of the auditor's performance.
ANSWER:
10.

Under which of the following circumstances may a CPA agree

with a departure from an accounting principle promulgated by
that body designated by AICPA Council to formulate such
principles?
a.
When the principle was one formulated by the Accounting
Principles Board inasmuch as the APB is no longer the
body so designated by Council.
b.
When the CPA can demonstrate that application of the
principle in question would make the financial
statements materially misleading.
c.
When the disputed principle is contrary to industry
practice.
d.
When adoption of the principle would cause the
financial statements to be inconsistent with prior
years.
ANSWER:

12

Chapter 2 Defining Professional Responsibility

11. Pursuant to the AICPA rules of conduct, the auditor's

responsibility to the profession is defined by
a.
The AICPA Code of Professional Conduct.
b.
Federal laws governing licensed professionals who are
involved in interstate commerce.
c.
Statements on Auditing Standards.
d.
The Bylaws of the AICPA.
ANSWER:
12.

An auditor who accepts an audit engagement and does not

possess the industry expertise of the business entity,
should
a.
Engage financial experts familiar with the nature of
the business entity.
b.
Obtain a knowledge of matters that relate to the
nature of the entity's business.
c.
Refer a substantial portion of the audit to another CPA
who will act as the principal auditor.
d. First inform management that an unqualified opinion
cannot be issued.
ANSWER:

13.

Which of the following factors is most important concerning

an auditor's responsibility to detect errors and fraud?
a.
The susceptibility of the accounting records to
intentional manipulations, alterations, and the
misapplication of accounting principles.
b.
The probability that unreasonable accounting
estimates result from unintentional bias or
intentional attempts to misstate the financial
statements.
c.
The possibility that management fraud, defalcations,
and misappropriation of assets may indicate the
existence of illegal acts.
d.
The risk that mistakes, falsifications, and omissions
may cause the financial statements to contain
material misstatements.
ANSWER:

14.

The standard of due audit care requires the auditor to

a.
Apply judgment in a conscientious manner, carefully
weighing the relevant factors before reaching a
decision.

Chapter 2 Defining Professional Responsibility

b.
c.
d.

Ensure that the financial statements are free from

error.
Make perfect judgment decisions in all cases.
Possess skills clearly above the average for the
profession.

ANSWER:
15.

The exercise of due professional care requires that an

auditor
a.
Examine all available corroborating evidence.
b.
Critically review the judgment exercised at every
level of supervision.
c.
Reduce control risk below the maximum.
d.
Attain the proper balance of professional experience
and formal education.
ANSWER:

16.

13

A CPA who has never audited a commercial bank

a.
May not accept such an engagement.
b.
May accept the engagement only if the accounting firm
specializes in the audit of commercial banks.
c.
May accept the engagement after attaining a suitable
level of understanding of the transactions and
accounting practices unique to commercial banking.
d.
May accept the engagement because training as a CPA
transcends unique industry characteristics.
ANSWER:

17. The first general standard requires that a person or

persons have adequate technical training and proficiency as
an auditor. This standard is met by
a.
An understanding of the field of business and finance.
b.
Education and experience in the field of auditing.
c.
Continuing professional education.
d.
A thorough knowledge of the Statements on Auditing
Standards.
ANSWER:

18. The first general standard recognizes that regardless of

how capable an individual may be in other fields, the
individual cannot meet the requirements of the auditing
standards without the proper
a.
Business and finance courses.

14

Chapter 2 Defining Professional Responsibility

b.
c.
d.

Quality control and peer review.

Education and experience in auditing.
Supervision and review skills.

ANSWER:
19.

In determining estimates of fees, an auditor may take into

account each of the following, except the
a.
Value of the service to the client.
b.
Degree of responsibility assumed by undertaking the
engagement.
c.
Skills required to perform the service.
d.
Attainment of specific findings.
ANSWER:

20. A CPA, while performing an audit, strives to achieve

independence in appearance in order to
a.
Reduce risk and liability.
b.
Comply with the generally accepted standards of field
work.
c.
Become independent in fact.
d.
Maintain public confidence in the profession.
ANSWER:

21. Which of the following best describes why publicly traded

corporations follow the practice of having the outside
auditor appointed by the board of directors or elected by
the stockholders?
a. To comply with the regulations of the Financial
Accounting Standards Board.
b. To emphasize auditor independence from the management
of the corporation.
c. To encourage a policy of rotation of the independent
auditors.
d. To provide the corporate owners with an opportunity to
voice their opinion concerning the quality of the
auditing firm selected by the directors.
ANSWER:

22. Which of the following is not required by the generally

accepted auditing standard that states that due
professional care is to be exercised in the performance of
the examination?

Chapter 2 Defining Professional Responsibility

a.
b.
c.
d.

Observance of the standards of field work and

reporting.
Critical review of the audit work performed at every
level of supervision.
Degree of skill commonly possessed by others in the
profession.
Responsibility for losses because of errors of
judgment.

ANSWER:
23.

15

The third general standard states that due care is to be

exercised in the performance of the examination. This
standard means that a CPA who undertakes an engagement
assumes a duty to perform each audit
a.
As a professional possessing the degree of skill
commonly possessed by others in the field.
b.
In conformity with generally accepted accounting
principles.
c.
With reasonable diligence and without fault or error.
d.
To the satisfaction of governmental agencies and
investors who rely upon the audit.
ANSWER:

COMPLETION:
24.

Client outsourcing of certain accounting functions, such

as internal auditing, to the national accounting firms may
cause financial statement users to question ___________
_______________.
ANSWER: AUDITOR INDEPENDENCE (OR INDEPENDENCE OF THE
AUDITOR)

25.

Through the
, the AICPA
has provided a framework for defining the acceptable quality
of independent audits and other services rendered by CPAs.
ANSWER:

26.

CODE OF PROFESSIONAL CONDUCT

Proper study and evaluation of internal accounting control

is needed because virtually all independent audits are
.
ANSWER:

TEST BASED

16

27.

Chapter 2 Defining Professional Responsibility

The generally accepted auditing standards, as promulgated by

the American Institute of Certified Public Accountants,
define the ______________ of independent auditing.
ANSWER:

28.

QUALITY

The general standards relate to the

of the auditor.
ANSWER:

and

CHARACTER, COMPETENCE

29. The field work standards are concerned with the

process.
ANSWER:
30.

AUDIT

The reporting standards relate to the

ANSWER:

function.

ATTEST

MATCHING:
31. Match each of the following actions with the Code of Conduct
rule violated by the action. No rule is used more than once.
Briefly explain why the action is a violation of the rule cited.
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.

Rule
Rule
Rule
Rule
Rule
Rule
Rule
Rule
Rule
Rule
Rule

101:
102:
201:
202:
203:
301:
302:
501:
502:
503:
505:

Independence
Integrity and objectivity
General standards
Compliance with standards
Accounting principles
Confidential client information
Contingent fees
Acts discreditable
Advertising and other forms of solicitation
Commissions and referral fees
Form of practice and name

____1. Juanita Garcia, CPA, refused to be associated with

a clients financial statements after the client
declined to correct a material misstatement. Garcia
later contacted James Jordan, CPA, retained by the
client to replace Garcia, and informed Jordan of the
misstatement.
____2. Brianna Lopez, CPA, agreed to review loan

Chapter 2 Defining Professional Responsibility

17

applications for First Charter Bank, an audit client.

The bank granted or denied the loans on the basis of
Lopez recommendations.
____ 3. In defense of a lawsuit alleging negligence, Melissa
Franklin, CPA, explained that she was not an expert in
commodities trading and therefore did not detect the
accounting fraud perpetrated by her client, a
commodities broker.
____ 4. Rudy Boesch, CPA, accepted an audit engagement
for a fixed fee of $27,000 plus 1% of audited net
assets.
____ 5. In reviewing the corporate tax return for Eager
Turnstiles, Inc., Abba Shah, CPA, discovered that
Eagers controller had incorrectly reported a $500,000
purchase of painting equipment as repairs expense.
When Shah informed the controller of the tax code
violation, she refused to correct the return. Shah
signed the return as preparer
____ 6. Ben Williams, CPA, issued an unqualified opinion on
a set of financial statements, even though he felt
uncomfortable about an accounting practice applied by
the client. Although the practice in question was in
accordance with GAAP, it increased net income
significantly above a level that Williams considered
reasonable.
____ 7. Jones Transfer Company wishes to defer charging
certain research and development expenditures to
current income on the basis that the expenditures
are virtually certain to benefit future operations.
For this reason, Jack Risher, CPA and Jones auditor,
agrees with the proposed accounting treatment.
SOLUTION:
1.

2.

f:

This is a violation of client confidence. Had

Garcia been contacted by Jordan, with her former
clients permission, she could have informed
Jordan of the disagreement.
a: The independence rule prohibits a member from being
associated with an audit client in any capacity
equivalent to that of a member of management.

18

Chapter 2 Defining Professional Responsibility

3.

c:

4.

g:

5.

d:

6.

b:

7.

e:

Making loan recommendations casts Lopez in that

capacity.
Rule 201 (A) Permits a member to undertake only
those engagements that the member or the members
firm can complete with professional competence.
Before accepting this engagement, therefore,
Franklin should have received training in
commodities trading and related accounting
practices.
A member is not permitted to perform an attest
engagement on a contingent fee basis. In this
case, the higher the audited net income, the
higher will be the audited net assets, and the
higher will be the audit fee. Such arrangements
impair auditor objectivity.
Rule 202 requires members to comply with all of
the standards governing the practice of public
accounting as set by those AICPA bodies
responsible for promulgating them. One of these
sets of standards is the Statements on
Responsibilities in Tax Practice, which prohibits
members from being associated with tax returns
known to contain material errors.
Rule 102 states that a member shall not knowingly
misrepresent facts or subordinate his or her
judgment to others. In this case, Williams, in
agreeing to the questionable practice,
subordinated his judgment to that of management,
thereby failing to adequately represent the
interests of the stockholders.
A member may not agree to a departure from an
accounting principle promulgated by the body
designated by Council to establish such
principles unless the departure is necessary in
order not to make the financial statements
materially misleading. In the present case,
inasmuch as the R & D expenditures are not
directly reimbursable, they must be charged to
expense in the current period; and, therefore,
Risher is wrong in agreeing to the departure
from GAAP.

Problem/Essay
33. John Block, CPA, has been approached by a prospective new
audit client, Snappy Enterprises, Inc. Snappy had previously
been audited by another CPA. Before accepting the engagement,

Chapter 2 Defining Professional Responsibility

19

Block discussed several matters with Snappys controller and

(with Snappys permission) the other CPA. As a result of these
discussions, the following information was obtained.
Incorporated in 1992, Snappys primary business is buying,
developing, selling, and leasing commercial real estate.
Apartment complexes, shopping malls, and industrial parks make up
the major portion of the companys business. Starting out in
Albuquerque, New Mexico and the surrounding area, Snappy
gradually expanded its operations to include most of southwestern
United States, including the Phoenix--Scottsdale--Mesa area of
Arizona.
After two years of losses, the company reported its first
earnings in 1994. From 1995 to 2000, revenues and earnings
increased dramatically. Earnings for 2001 and 2002, however
declined from earlier levels. For the current year, 2003,
unaudited net income has rebounded to the 2000 level.
Block has learned from discussions with Snappys controller
that, as of 12/31/03, the end of the current year, the company
was in the process of completing a major mall project. The
company currently owns several apartment complexes and leases its
completed shopping malls to numerous retail establishments.
After having been developed, industrial properties are sold
either to municipalities or to companies locating in the
complexes.
In discussing past audits with the CPA formerly engaged by
Snappy, Block learned that several disagreements had arisen over
the years, many of which had not been resolved to the
satisfaction of the former auditors. The disagreements related
to accounting matters as well as to the substance of certain
transactions with lessees.
Required:
a.
In deciding whether to accept this engagement, what
factors should Block consider?
b.
If he decides to accept the engagement, in what areas
should he concentrate his audit resources?
SOLUTION:
a.

Factors Block should consider are the following:

1.
Seriousness of disagreements with the prior
auditor and their potential impact on the
financial statements
2.
Whether the disagreements demonstrate lack of
management integrity

20

Chapter 2 Defining Professional Responsibility

3.

Competence of Block to satisfactorily perform the

audit
b.
The increase in unaudited earnings suggests possible
overstatement of revenues or understatement of
expenses. For this reason, Block should
focus on the
following areas:
1.
Cost allocations to the uncompleted mall project.
Operating expenses may have been inappropriately
allocated to the project and reflected as
assets
2.
Adequacy of provisions for uncollectible lease
rentals
3.
Whether financing leases have been incorrectly
treated as sales type leases
4.
Whether revenues or gains have been improperly
recognized as a result of transactions with
lessees (related parties)