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,arereprintedwith
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1.
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2.
InformationforUniformCPAExaminationCandidates,BoardofExaminers,2000.
3.
MaterialfromtheCertifiedInternalAuditorExamination,Copyright 1994through1997bytheInstituteofIn
ternalAuditors,Inc.,arereprintedand/oradaptedwithpermission.
4.
MaterialfromtheCertifiedManagementAccountantExaminations,Copyright 1993through1997bytheIn
stituteofCertifiedManagementAccountants,arereprintedand/oradaptedwithpermission.
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PREFACE
PassingtheCPAexamuponyourfirstattemptispossible!TheWileyCPAExaminationReviewpreparationma
terialsprovideyouwiththenecessarymaterials(visitourWebsiteatwww.wiley.com/cpaformoreinformation).Itsup
toyoutoaddthehardworkandcommitment.Togetherwecanbeatthefirsttimepassrateoflessthan50%.AllWiley
CPAproductsarecontinuouslyupdatedtoprovideyouwiththemostcomprehensiveandcompleteknowledgebase.
ChooseyourproductsfromtheWileypreparationmaterialsandyoucanproceedconfidently.Youcanselectsupport
materialsthatareexambasedanduserfriendly.Youcanselectproductsthatwillhelpyoupass!
ThefirstpurposeofVolume2istoprovideCPAcandidateswithsampleexaminationproblems/questionsorganized
bytopic(e.g.,internalcontrol,consolidations,etc.).Thistextincludesover2,600multiplechoicequestions.These
questionsprovideaneffectivemeansofstudyingthematerialtestedonpastexams;however,itisalsonecessarytowork
withtaskbasedsimulationstodevelopthesolutionsapproach(theabilitytosolveCPAquestionsandproblems
efficiently).
ThesecondobjectiveofthisvolumeistoexplaintheAICPAunofficialanswersandauthorquestionanswerstothe
examinationproblems/questionsincludedinthistext.TheAICPApublishedallCPAexaminationsandunofficialan
swersthroughtheNovember1995examandselectedquestionsandanswerssincethen.Noexplanationismade,how
ever,oftheproceduresthatshouldhavebeenappliedtotheexaminationproblemtoobtaintheunofficialanswers.Relat
edly,theunofficialanswerstomultiplechoicequestionsprovidenojustificationand/orexplanation.Thistextprovides
explanationsofbothhowtoworkproblemsandtheunofficialanswerstomultiplechoicequestions.
ThistextisdesignedtobeusedinconjunctionwithVolume1,OutlinesandStudyGuides,butmaybeusedwithor
withoutanyotherstudysource.Bothvolumesareorganizedinto47manageablestudyunits(modules)toassistcandi
datesinorganizingtheirstudyprograms.Themultiplechoicequestionsinthisvolumearegroupedintotopicalcatego
ries(submodules)thatcorrespondtothesequencingofmaterialasitappearsinVolume1.
NewauthorconstructedquestionshavebeenaddedtothisThirtyEighthEdition.Asnewquestionsandproblems
areadded,olderonesaredeleted.Newproblemshavebeenaddedtoaddressthenewcontentoftheexamthatwas
adoptedJanuary1,2011.
ASampleExaminationforeachofthefourpartsoftheexamisincludedintheAppendixattheendofthisvolume.
TheCPAexamisoneofthetoughestexamsyouwillevertake.Itwillnotbeeasy.Butifyoufollowourguidelines
andfocusonyourgoal,youwillbethrilledwithwhatyoucanaccomplish.
RayWhittington
April2011
DontforgettovisitourWebsiteatwww.wiley.com/cpa
forsupplementsandupdates.
1HOWTOUSETHISBOOK
2
CONTENTS
AUDITINGANDATTESTATION
7
*
ProfessionalResponsibilities
EngagementPlanning,ObtaininganUnderstanding
oftheClientandAssessingRisks
UnderstandingInternalControlandAssessing
ControlRisk
RespondingtoRiskAssessment:Evidence
AccumulationandEvaluation
Reporting
AccountingandReviewServices
AuditSampling
AuditingwithTechnology
Module
Abbreviations
Numbers
RESP
1
ENPL
24
IC
67
EVID
REPT
AARS
AUDS
ATEC
4
5
6
7
8
113
163
202
214
230
3FINANCIALACCOUNTINGANDREPORTING
239
BasicTheoryandFinancialReporting
TREP
241
Inventory
FixedAssets
MonetaryCurrentAssetsandCurrentLiabilities
PresentValue
INVY
FA
CACL
PV
10
11
12
13
333
361
392
426
DeferredTaxes
StockholdersEquity
Investments
StatementofCashFlows
BusinessCombinationsandConsolidations
DerivativeInstrumentsandHedgingActivities
Miscellaneous
DETX
STK
IVES
SCF
BCC
DIHA
MISC
14
15
16
17
18
19
20
494
513
546
573
592
617
634
Governmental(StateandLocal)Accounting
NotforProfitAccounting
GOV
NFP
21
22
670
695
A.BasicConcepts
B.ErrorCorrection
C.AccountingChanges
D.FinancialStatements
A.Fundamentals
B.Bonds
C.DebtRestructure
D.Pensions
E.Leases
A.PersonalFinancialStatements
B.InterimReporting
C.SegmentReporting
D.PartnershipAccounting
E.ForeignCurrencyTranslation
4 REGULATION
241
268
280
295
426
437
456
460
473
634
638
642
649
661
711
AsexplainedinChapter1,thisvolumeisorganizedinto47modules(manageablestudyunits).Volume1isorganizedinaparallel
fashion.
PROFESSIONALRESPONSIBILITIESANDBUSINESSLAW
ProfessionalandLegalResponsibilities
FederalSecuritiesActs
BusinessStructure
Contracts
Sales
CommercialPaper
SecuredTransactions
Bankruptcy
DebtorCreditorRelationships
Agency
RegulationofEmploymentandEnvironment
Property
713
Module
Abbreviations
Numbers
PLR
23
FEDE
24
BSTR
25
CONT
26
SALE
27
CPAP
28
SECU
29
BANK
30
DBCR
31
AGEN
32
EMEN
33
PROP
34
6FEDERALTAXATION
IndividualTaxation
TransactionsinProperty
PartnershipsTaxation
CorporateTaxation
GiftandEstateTaxation
861
ITAX
TPRO
PTAX
CTAX
GETX
35
36
37
38
39
7BUSINESSENVIRONMENTANDCONCEPTS
CorporateGovernance,InternalControl,and
EnterpriseRiskManagement
InformationTechnology
Economics,Strategy,andGlobalization
FinancialRiskManagementandCapitalBudgeting
FinancialManagement
PerformanceMeasures
CostMeasurement
Planning,Control,andAnalysis
714
730
742
761
778
793
810
818
829
837
845
856
862
931
948
974
1031
1055
CGIC
IFTC
ECON
RMCB
FINM
PERM
COST
PLAN
40
41
42
43
44
45
46
47
1056
1066
1093
1114
1132
1158
1171
1186
APPENDIXA:SAMPLEEXAMINATIONS
1207
APPENDIXB:SAMPLETESTLETSRELEASEDFROMTHEAICPA
1299
APPENDIXC:2011RELEASEDAICPAQUESTIONS
1323
ABOUTTHEAUTHORS
RayWhittington,PhD,CPA,CMA,CIA,isthedeanoftheCollegeofCommerceatDePaulUniversity.Prior
tojoiningthefacultyatDePaul,ProfessorWhittingtonwastheDirectorofAccountancyatSanDiegoStateUniversity.
From1989through1991,hewastheDirectorofAuditingResearchfortheAmericanInstituteofCertifiedPublicAc
countants(AICPA),andhepreviouslywasontheauditstaffofKPMG.HepreviouslyservedasamemberoftheAudit
ingStandardsBoardoftheAICPAandasamemberoftheAccountingandReviewServicesCommitteeandtheBoardof
RegentsoftheInstituteofInternalAuditors.ProfessorWhittingtonhaspublishednumeroustextbooks,articles,mono
graphs,andcontinuingeducationcourses.
PatrickR.Delaney,deceased,wasthededicatedauthorandeditoroftheWileyCPAExamReviewbooksfor
twentyyears.HewastheArthurAndersenLLPAlumniProfessorofAccountancyandDepartmentChairatNorthern
IllinoisUniversity.HereceivedhisPhDinAccountancyfromtheUniversityofIllinois.Hehadpublicaccounting
experiencewithArthurAndersenLLPandwascoauthorofGAAP:InterpretationandApplication,alsopublishedby
JohnWiley&Sons,Inc.HeservedasVicePresidentandamemberoftheIllinoisCPASocietysBoardofDirectors,and
wasChairmanofitsAccountingPrinciplesCommittee;wasapastpresidentoftheRockfordChapter,Instituteof
ManagementAccountants;andhadservedonnumerousotherprofessionalcommittees.Hewasamemberofthe
AmericanAccountingAssociation,AmericanInstituteofCertifiedPublicAccountants,andInstituteofManagement
Accountants.ProfessorDelaneywaspublishedinTheAccountingReviewandwasarecipientoftheIllinoisCPA
SocietysOutstandingEducatorAward,NIUsExcellenceinTeachingAward,andLewisUniversitysDistinguished
AlumnusAward.HewasinvolvedinNIUsCPAReviewCourseasdirectorandinstructor.
ABOUTTHECONTRIBUTORS
AnitaL.Feller,PhD,CPA,isaLecturerinAccountancyattheUniversityofIllinoisatUrbanaChampaign.She
istherecipientoftheCommerceCouncilExcellenceinTeachingAward.Formerlyastaffaccountantinthetax
departmentatKPMGPeatMarwick,sheteachescoursesinfinancialaccountingandappliedprofessionalresearch.
ProfessorFelleralsoteachesfinancialandmanagerialtopicsintheUniversityofIllinoisCPAReviewCourse.Sheis
alsotheauthorof
MasteringAccountingResearchfortheCPAExamandWileyCPAExamReviewImpactAudios(bothpublished
byWiley).
EdwardC.Foth,PhD,CPA,istheAdministratoroftheMasterofScienceinTaxationProgramatDePaulUniver
sity.HeisamemberoftheAmericanAccountingAssociation,theAmericanInstituteofCertifiedPublicAccountants,
theIllinoisCPASociety,andtheAmericanTaxationAssociation.HehasbeenarecipientoftheLedger&QuillFaculty
ExcellenceAward,andistheauthorofCCHIncorporatedsFederalTaxStudyManual,FederalTaxation
RefresherCourse,andiscoauthoroftheirSCorporationsGuide.HepreparedChapter6.
MarkL.Frigo,PhD,CPA,CMA,isDirectorofTheCenterforStrategy,ExecutionandValuationin
KellstadtGraduateSchoolofBusinessandEichenbaumFoundationDistinguishedProfessorofStrategyand
LeadershipintheSchoolofAccountancyatDePaulUniversity.ProfessorFrigoauthoredthePerformanceMeasures
modulefortheBusinessEnvironmentandConceptssectionofthismanual.
KurtPany,PhD,CPA,isaProfessorofAccountingatArizonaStateUniversity.Priortoenteringacademe,
heworked as a staff auditor for Deloitte and Touche LLP. He is a former member of the AICPAs Auditing
StandardsBoardandhastaughtintheArizonaStateUniversityCPAReviewCourse.
PatriciaL.Smith,MBA,CPA,isaninstructorintheSchoolofAccountancyatDePaulUniversity.Shehas
abackgroundinauditingandfinancialaccounting.ShehasauditexperiencewithKPMG.Shecontributedtotheauditing
modules.
HOWTOUSETHISBOOK
ThisvolumeisacollectionofCPAquestions,taskbasedsimulationsandsolutions.Thetextisdesigned
andorganizedtobeusedinconjunctionwithVolume1,CPAExaminationReview:OutlinesandStudyGuides,
butmaybeusedwithorwithoutanyotherstudysource.Eachmoduleinthisvolumecorrespondstoamodule
inVolume1.Inthisvolume,amoduleconsistsof
1.
2.
3.
4.
5.
Multiplechoicequestions
Taskbasedsimulations
Writtencommunicationtasks
Unofficialanswersforthemultiplechoicequestionswiththeauthorsexplanations
Answersfortaskbasedsimulations
Thesourcesofthequestionsandtaskbasedsimulationsmaterialineachmoduleare,ofcourse,thefour
sectionsoftheCPAExam.Themodulesaregroupedtogetherintochapters,whichcorrespondwiththefour
sectionsoftheexam.ThefollowingtableshowshowthemodulesareorganizedinVolume2.
ThismanualhasbeenupdatedforthemajorchangesthatoccurredintheCPAexameffectiveJanuary1,
2011.
CPAEXAMSECTIONANDCORRESPONDINGMODULES
AuditingandAttestation
FinancialAccountingandReporting
Regulation
BusinessEnvironmentandConcepts
CH2
CH3
CH5&6
CH7
Modules16
Modules720
Modules2137
Modules3845
ThematerialinVolume2allowscandidatestoworkCPAexamquestions,someofwhichhaveappearedon
previousexaminations.Thisprovidescandidateswithaneffectivemethodofstudyingthematerialtestedonthe
exam.However,candidatesshouldalsorealizethattheCPAhasnewmaterial.Therefore,candidatesshoulduse
thestudyguidesandoutlinesincludedinVolume1asameansofbridgingthisgap.
Alsoincludedattheendofthisvolumearesampleexamsforallfoursections.Theyareincludedtoen
ablecandidatestogainexperienceintakingarealisticexam.Whileworkingthroughthemodules,thecan
didatecanbecomeaccustomedtoconcentratingonafairlynarrowrangeoftopics.Bytakingthesampleex
aminationsneartheendoftheirstudyprogram,candidateswillbebetterpreparedfortakingtheactual
examination.
BeforeyoubeginworkingtheCPAquestionsinthisvolume,perusethetableofcontentsandscanthrough
thebook,notingthemannerinwhichthechaptersandmodulesareorganized.Thescheduleatthebeginning
ofeachchapterprovidesanindextothequestionsappearingineachmodule.Somequestionshavebeen
modifiedtoreflectrecentchangesinlaworpractice.Foracompleteanalysisofrecentexaminationsandthe
AICPAUniformCPAExaminationContentSpecificationOutlinesoffutureexaminations,seethebeginning
ofeachchapterstartingwithChapter5inVolume1,OutlinesandStudyGuides.
MultipleChoiceQuestions
Themultiplechoicequestionsandanswerexplanationscanbeusedinmanyways.First,theymaybe
usedasadiagnosticevaluationofyourknowledge.Forexample,beforebeginningtoreviewauditsampling
youmaywishtoanswereveryfourthmultiplechoicequestiontodetermineyourabilitytoanswerCPAex
aminationquestionsonauditsampling.Theapparentdifficultyofthequestionsandthecorrectnessofyour
answerswillallowyoutodeterminethenecessarybreadthanddepthofyourreview.Additionally,exposure
toexaminationquestionspriortoreviewandstudyofthematerialshouldprovidemotivation.Youwillde
velopafeelforyourlevelofproficiencyandanunderstandingofthescopeanddifficultyofpastexamination
questions.
Second,themultiplechoicequestionscanbeusedasapoststudyorpostreviewevaluation.Youshould
attempttounderstandallconceptsmentioned(eveninincorrectanswers)asyouanswerthequestions.Refer
totheexplanationoftheanswerfordiscussionofthealternativeseventhoughyouselectedthecorrectre
CH1HOWTOUSETHISBOOK
sponse.Thus,youshouldreadtheexplanationoftheunofficialanswerunlessyoucompletelyunderstandthe
questionandallofthealternativeanswers.
Third,youmaywishtousethemultiplechoicequestionsasaprimarystudyvehicle.Thisisprobablythe
quickest,butleastthorough,approach.Makeasincereefforttounderstandthequestionandtoselectthecor
rectreplybeforereferringtotheanswerandexplanation.Inmanycasestheexplanationswillappearinade
quatebecauseofyourunfamiliaritywiththetopic.
ThemultiplechoicequestionsinVolume2aregroupedintostudysets.Thestudysetsincludeasmaller
amountofrelatedmaterialthanthestudymodules,whichprovidesgreaterflexibilityintheindividualcandi
datesstudystrategy.TheanswerexplanationsforthemultiplechoicequestionsinVolume2alsoinclude
headingswhichprovidecrossreferencestothetextmaterialinVolume1.Forexample,inModule11,Fixed
Assets,theheadingF.Depreciationappearsabovetheanswerstothosequestionsdealingwithdepreciation.
ThetopicalcoverageofdepreciationinVolume1canthenbefoundbyreferringtothecorresponding
headingwithinModule11.
Oneofthebenefitsofworkingthroughmultiplechoicequestionsisthatithelpsyoutoidentifyyour
weakareas.Onceyouhavegradedyouranswers,yourstrongareasandweakareasshouldbeclearlyevident.
Yet,theimportantpointhereisthatyoushouldnotstopatasimplepercentageevaluation.Thepercentage
onlyprovidesgeneralfeedbackaboutyourknowledgeofthematerialcontainedwithinthatparticularmodule.
Thepercentagedoesnotgiveyouanyspecificfeedbackregardingtheconceptswhichweretested.Inorderto
getthisfeedback,youshouldlookatthequestionsmissedonanindividualbasisbecausethiswillhelpyou
gainabetterunderstandingofwhyyoumissedthequestion.Thisfeedbackprocesshasbeenfacilitatedbythe
factthatwithineachmodulewherethemultiplechoiceanswerkeyappears,twoblanklineshavebeen
insertednexttothemultiplechoiceanswers.Asyougradethemultiplechoicequestions,markthose
questionswhichyouhavemissed.However,insteadofjustmarkingthequestionsrightandwrong,you
shouldnowfocusonmarkingthequestionsinamannerwhichidentifieswhyyoumissedthequestion.Asan
example,acandidatecouldmarkthequestionsinthefollowingmanner:formathmistakes,xforconceptual
mistakes,and?forareaswhichthecandidatewasunfamiliarwith.Thecandidateshouldthencorrectthese
mistakesbyreworkingthroughthemarkedquestions.Theobjectiveofthismarkingtechniqueistohelpyou
identifyyourweakareasandthus,theconceptswhichyoushouldbefocusingon.Whileitisstillimportant
foryoutogetbetween75%and80%correctwhenworkingmultiplechoicequestions,itismoreimportant
foryoutounderstandtheconcepts.Thisunderstandingappliestoboththequestionsansweredcorrectlyand
thoseansweredincorrectly.Remember,mostofthequestionsontheCPAexamwillbedifferentfromthe
questionsinthebook;however,theconceptswillbethesame.Therefore,yourpreparationshouldfocuson
understandingconcepts,notjustgettingthecorrectanswer.
Themultiplechoicequestionssubstantiallyoutnumberthetaskbasedsimulationsinthisbook.Thisis
similartowhatcanbeexpectedontheCPAexam.Themultiplechoicequestionsmakeupaboutbetween
60%and85%(dependingonthesection)ofthetotalexamination.
Onedifficultywithsomanymultiplechoicequestionsisthatyoumayoveremphasizethem.Candidates
generallyprefertoworkmultiplechoicequestionsbecausetheyareshorterandlesstimeconsumingand
solvablewithlesseffort.
Anotherdifficultywiththelargenumberofmultiplechoicequestionsisthatyoumaytendtobecome
overlyfamiliarwiththequestions.Theresultmaybethatyoumaybeginreadingthefactsandassumptionsof
previouslystudiedquestionsintothequestionsonyourexamination.Guardagainstthispotentialproblemby
readingeachmultiplechoicequestionwithextracare.
Althoughnotascriticalasfortaskbasedsimulations,thesolutionsapproach(asystematicproblem
solvingmethodology)isrelevanttomultiplechoicequestions.
MultipleChoiceScreenLayout
Thefollowingisacomputerscreenshotthatillustratesthemannerinwhichmultiplechoicequestionswill
bepresented:
CH1HOWTOUSETHISBOOK
Asindicatedpreviously,multiplechoicequestionswillbepresentedinthreeindividualtestletsof24to
30questionseach.Characteristicsofthecomputerizedtestletsofmultiplechoicequestionsincludethe
following:
3.
4.
6.
1. Youmaymovefreelywithinaparticulartestletfromonequestiontothenextorbacktoprevious
questionsuntilyouclicktheExitbutton.Onceyouhaveindicatedthatyouhavefinishedthe
testletbyclickingontheExitbuttonandreconfirmed,youcanneverreturntothatsetof
questions.
2. Abuttononthescreenwillallowyoutoflagaquestionforreviewifyouwishtocomebackto
itlater.
Afourfunctioncomputercalculatorwithanelectronictapeisavailableasatool.
Thetimeremainingfortheentireexamsectionisshownonthescreen.
5. Thequestionswillbeshownatthebottomofthescreen.Youmaynavigatebetweenquestions
bysimplyclickingonthequestionnumber.
TheHelpbuttonwillprovideyouwithhelpinnavigatingandcompletingthetestlet.
ThescreenshotabovewasobtainedfromtheAICPAssampleexamatwww.cpaexam.org.Candidates
are urged to complete the tutorial and other example questions on the AICPAs Web site to obtain
additionalexperiencewiththecomputerbasedtesting.
1.
MultipleChoiceQuestionsSolutionsApproach
Workindividualquestionsinorder.
a. Ifaquestionappearslengthyordifficult,skipituntilyoucandeterminethatextratimeis
available.Markitforreviewtoremindyoutoreturntoitlater.
2.
Readthestemofthequestionwithoutlookingattheanswers.
a. The answers are sometimes misleading and may cause you to misread or misinterpret the
question.
3.
Readeachquestioncarefullytodeterminethetopicalarea.
a. Studytherequirementsfirstsoyouknowwhichdataareimportant
b. Notekeywordsandimportantdata
c. Identifypertinentinformation
d. Beespeciallycarefultonotewhentherequirementisan exception (e.g.,Whichofthe
followingisnotaneffectivedisclaimeroftheimpliedwarrantyofmerchantability?).
e. Ifasetofdataisthebasisfortwoormorequestions,readtherequirementsofeachofthe
questionsbeforebeginningtoworkthefirstquestion(sometimesitismoreefficientto
workthequestionsoutoforder)
CH1HOWTOUSETHISBOOK
f.
Bealerttoreadquestionsastheyare,notasyouwouldlikethemtobe.Youmayencountera
familiar looking item; dont jump to the conclusion that you know what the answer is
withoutreadingthequestioncompletely.
Anticipatetheanswerbeforelookingatthealternativeanswers.
4.
a. Recalltheapplicableprinciple(e.g.,offerandacceptance,requisitesofnegotiability,etc.)
andtherespectiveapplicationsthereof.
b. Ifaquestiondealswithacomplexarea,itmaybeveryusefultosetupatimelineordiagram
usingabbreviations.
Readtheanswersandselectthebestalternative.
Clickonthecorrectanswer(oryoureducatedguess).
7. AftercompletingallofthequestionsincludingtheonesmarkedforreviewclickontheDone
buttontocloseoutthetestlet.Rememberonceyouhaveclosedoutthetestletyoucanneverre
turntoit.
5.
6.
Currently,allmultiplechoicequestionsarescoredbasedonthenumbercorrect,weightedbyadifficulty
rating(i.e.,thereisnopenaltyforguessing).Therationaleisthatagoodguessindicatesknowledge.Thus,
youshouldanswerallmultiplechoicequestions.
TaskBasedSimulations
Simulationsarecasebasedproblemsdesignedto
Testintegratedknowledge
Morecloselyreplicaterealworldproblems
Assessresearchandotherskills
Anyofthefollowingtypesofresponsesmightberequiredontaskbasedsimulations:
Dropdownselection
Numericandmonetaryinputs
Formulaanswers
Checkboxresponse
Enterspreadsheetformulas
Researchresults
Tocompletethesimulations,candidatesareprovidedwithanumberoftools,including
Afourfunctioncomputercalculatorwithanelectronictape
Scratchspreadsheet
Theabilitytosplitwindowshorizontallyorverticallytoshowtwotabsonthescreen(e.g.,youcan
examinethesituationtabinonewindowandarequirementtabinasecondwindow)
Accesstoprofessionalliteraturedatabasestoanswerresearchrequirements
Copyandpastefunctions
Inaddition,theresourcetabprovidesotherresourcesthatmaybeneededtocompletethesimulation.For
example,aresourcetabmightcontainapresentvaluetableforuseinansweringaleaseproblem.Awindow
onthescreenshowsthetimeremainingfortheentireexam,andtheHelpbuttonprovidesinstructionsfor
navigatingthesimulationandcompletingtherequirements.
TaskBasedSimulationsSolutionsApproach
Thefollowingsolutionsapproachissuggestedforansweringsimulations:
1.
Reviewtheentirebackgroundandproblem.Getafeelforthetopicalareaandrelatedconcepts
thatarebeingtested.Eventhoughtheformatofthequestionmayvary,theexamcontinuestotestyour
understandingofapplicableprinciplesorconcepts.Relax,takeadeepbreath,anddetermineyourstrategyfor
conqueringthesimulation.
2. Identifytherequirementsofthesimulation. Thisstepwillhelpyoufocusinmorequicklyon
thesolution(s)withoutwastingtimereadingirrelevantmaterial.
3. Studytheitemstobeanswered.Asyoudothisandbecomefamiliarwiththetopicalarea
beingtested,youshouldreviewtheconceptsofthatarea.Thiswillhelpyouorganizeyourthoughts
sothatyoucanrelatelogicallytherequirementsofthesimulationwiththeapplicableconcepts.
CH1HOWTOUSETHISBOOK
4. Usethescratchpaper(whichwillbeprovided)andthespreadsheetandcalculatortoolsto
assistyouinansweringthesimulation.
YouareurgedtocompletethetutorialandothersampleteststhatareontheAICPAsWebsite
(www.cpaexam.org)toobtainadditionalexperiencewiththeinterfaceandcomputerbasedtesting.
TaskBasedResearchSimulations
OneresearchsimulationwillbeincludedontheAuditingandAttestation,FinancialAccountingand
Reporting,andRegulationsectionsoftheexam.Researchsimulationsrequirecandidatestosearchthe
professionalliteratureandincometaxcodeinelectronicformatandinterprettheresults.Thetablebelow
describestheresearchmaterialthatwillbeavailableforeachsectionoftheexamthatincludesresearch
simulations.
AuditingandAttestation
Section
Potentialresearchresources
AICPAStatementsonAuditingStandardsand
Interpretations(AU)
PCAOBAuditingStandardsandInterpretations
(PCAOB)
AICPAStatementsonAttestationStandardsand
Interpretations(AT)
AICPAStatementsonStandardsforAccountingand
ReviewServicesandInterpretations(AR)
AICPACodeofProfessionalConduct(ET)
AICPABylaws(BL)
AICPAStatementsonStandardsforValuationServices
(VS)
AICPAStatementonStandardsforConsultingServices
(CS)
AICPAStatementsonStandardsforQualityControl
(QC)
AICPAPeerReviewStandards(PR)
AICPAStatementonStandardsforTaxServices(TS)
AICPAStatementonResponsibilitiesinPersonal
FinancialPlanningPractice(PFP)
AICPAStatementonStandardsforContinuing
ProfessionalEducationPrograms(CPE)
FinancialAccountingandReporting
FASBAccountingStandardsCodification
Regulation
InternalRevenueCode
Theresearchmaterialmaybesearchedusingthetableofcontentsorakeywordsearch.Therefore,
knowingimportantcodesections,FASBcodificationsections,auditingstandardssectionnumbers,etc.
mayspeedupyoursearch.
Ifpossible,itisimportanttogetexperienceusinganelectronicversionoftheresearchdatabasesto
sharpenyourskills.Ifthatisnotavailable,youshouldusetheprintedcopyoftheprofessionalstandardsand
theIRScodeandregulationstoanswerthesimulationsinthemanual.Remember,theAICPAoffersan
electronicversionofprofessionalstandardstoregisteredcandidates.RefertotheAICPAWebsiteat
www.cpaexam.org.
WrittenCommunicationTasks
TheBusinessEnvironmentandConceptssectionoftheexamwillrequirethecompletionofthree
writtencommunicationquestions.Communicationquestionswillinvolvesomerealworldwriting
assignmentthataCPAmighthavetoperform,suchasamemorandumtoaclientexplainingamanagement
technique.ThesubjectofthecommunicationwillbeaBusinessEnvironmentandConceptstopic.
Itisessentialforthecommunicationtobeinyourownwords.Inaddition,thecommunicationwillnotbe
gradedfortechnicalaccuracy.Ifitisonpoint,itwillonlybegradedforusefulnesstotheintendeduserand
writingskills.Thefollowingscreenshotillustratesataskrequiringthecompositionofamemorandumtoa
companypresident.
CH1HOWTOUSETHISBOOK
DiagnoseYourWeaknessespriortotheExam
Thisvolumeofquestions,taskbasedsimulationsandsolutionsprovidesyouwithanopportunityto
diagnoseandcorrectanyexamtakingweaknessespriortoyourtakingtheexamination.Continuouslyanalyze
thecontributingfactorstoincompleteorincorrectsolutionstoCPAquestionspreparedduringyourstudy
program.Generalcategoriesofcandidatesweaknessesinclude
1.
2.
3.
5.
6.
7.
8.
Failuretounderstandtheexamquestionrequirements
Misunderstandingthesupportingtextofthequestion
Lackofknowledgeofmaterialtested,especiallyrecentlyissuedpronouncements
4. Failuretodevelopproficiencywithpracticetoolssuchaselectronicresearchdatabasesandspread
sheets
Inabilitytoapplythesolutionsapproach
Lackofanexamstrategy(e.g.,allocationoftime)
Sloppinessandcomputationalerrors
Failuretoproofreadandedit
TimeManagement
EachsectionoftheCPAexamwillcontainanumberofmultiplechoicetestlets,andallofthesectionsex
ceptBusinessEnvironmentandConceptswillcontaintwosimulations.Asyoucompleteeachtestletkeep
trackofhowyouperformedinrelationtotheAICPAsuggestedtimes.Afteryoufinishthemultiplechoice
testlets,budgetyourtimeforthesimulationsbasedonyourremainingtimeandtheAICPAsuggestedtimes.
Forexample,ifyouhavetwohoursremainingtocompletetwosimulationsthateachhavethesameAICPA
suggestedtime,budgetonehourforeachsimulation.Rememberthatyoualonecontrolwatchingyourprog
resstowardssuccessfullycompletingthisexam.
AdditionalStudyAids
Amorecompletediscussionofthesolutionsapproach,includingillustrationsthereof,appearsinChapter3
ofVolume1,OutlinesandStudyGuides.Additionally,useofnotecardsasanintegralpartofyourstudy
programisdiscussedandillustratedinChapter1ofVolume1.Chapter4ofVolume1includesadetailed
checklisttoassistcandidateswiththeirlastminutepreparationandtoprovideguidanceconcerningtheactual
takingoftheexam.
NOWISTHETIME
TOMAKEACOMMITMENT
AUDITINGANDATTESTATION
TheAuditingandAttestationExamisscheduledforfourandonehalfhours.Basedoninformationreleasedbythe
AICPA,candidatesshouldexpectthreemultiplechoicetestletsofapproximatelythirtyquestionseach,andtwo
simulations.TheUniformCPAExaminationContentSpecificationsappearinVolume1,OutlinesandStudy
Guides.
Module1/ProfessionalResponsibilities(RESP)
39MultipleChoice
7TaskBasedSimulations
8
12
17
21
Module2/EngagementPlanning,ObtaininganUnderstandingoftheClientand
AssessingRisks(ENPL)
113 MultipleChoice
14 TaskBasedSimulations
24
34
47
59
Module3/UnderstandingInternalControlandAssessingControlRisk(IC)
166 MultipleChoice
9 TaskBasedSimulations
67
82
91
109
Module4/RespondingtoRiskAssessment:EvidenceAccumulationandEvaluation
(EVID)
169 MultipleChoice
13 TaskBasedSimulations
113
128
137
156
163
179
183
200
202
207
208
213
214
220
222
229
Module5/Reporting(REPT)
164 MultipleChoice
4 TaskBasedSimulations
Module6/AccountingandReviewServices(AARS)
49 MultipleChoice
1 TaskBasedSimulations
Module7/AuditSampling(AUDS)
58 MultipleChoice
3 TaskBasedSimulations
Module8/AuditingwithTechnology(ATEC)
32 MultipleChoice
1 TaskBasedSimulation
230
233
234
238
AuditingandAttestationSampleExamination
1207
AuditingandAttestationRegulationAICPASampleTestlets
1299
AuditingandAttestation2011ReleasedAICPAQuestions
1323
MODULE1PROFESSIONALRESPONSIBILITIES
PROFESSIONALRESPONSIBILITIES
MULTIPLECHOICEQUESTIONS(139)
1.
d.
2.
universal
application.
b. Pronouncementsissued
by the Auditing
StandardsBoard.
c. Measures of the
quality of the
auditors perfor
mance.
Procedures to be used to gather
evidence to support financial
statements.
d.
4.
Whichofthefollowingisa
self review threat to
memberindependence?
a. An
engagemen
t team
member
has a
spousethat
serves as
CFOofthe
attest
client.
b. A second
partner
review is
requiredon
all attest
engagemen
ts.
c. An
engagement
team
member
prepares
invoicesfor
the attest
client.
d. An
engagement
team member
has a direct
financial
interest in the
attestclient.
5.
Accordingtothestandardsofthe
profession, which of the
following circumstances will
preventaCPAperformingaudit
engagements from being
independent?
a. Obtaining a
collateralized
automobile
loan from a
financial
institution
client.
b. Litigation
with a client
relating to
billing for
consulting
services for
which the
amount is
immaterial.
c. Employment
Forwhichofthefollowingcana
memberoftheAICPAreceivean
automatic expulsion from the
AICPA?
I.Memberisconvictedofafelony.
II.Memberfileshisownfraudulenttax
return.
BI. Member
files
fraudulent tax return
for a client knowing
thatitisfraudulent.
a.
b.
c.
d.
Ionly.
IandIIonly.
IandIIIonly.
I,II,andIII.
3.
Whichofthefollowingisan
example of a safeguard
implementedbytheclientthat
might mitigate a threat to
independence?
a. Requir
ed
contin
uing
educati
on for
all
attest
engage
ment
team
membe
rs.
An effective corporate
governancestructure.
c. Requir
ed
second
partner
review
of an
b.
attest
engage
ment.
ManagementselectionoftheCPA
firm.
d.
6.
a.
oftheCPAs
spouse as a
clients di
rector of
internal
audit.
Actingasan
honorary
trusteefora
notfor
profit
organization
client.
b.
c.
d.
7.
a.
Theprofessionsethical
standardsmostlikelywouldbe
consideredtohavebeenviolated
whenaCPArepresentsthat
specificconsultingserviceswill
beperformedforastatedfeeand
itisapparentatthetimeofthe
representationthatthe
Actualfeewouldbesubstantially
higher.
b.
c.
d.
8.
a.
b.
c.
d.
9.
a.
b.
Issuing a modified
report explaining a
failure to follow a
governmental
regulatory agencys
standards when
conducting an attest
serviceforaclient.
Revealing confidential
client information
duringaqualityreview
of a professional
practicebyateamfrom
thestateCPAsociety.
Acceptingacontingent
feeforrepresentinga
clientinanexamination
oftheclientsfederal
taxreturnbyanIRS
agent.
Retainingclientrecords
afteranengagementis
terminatedpriorto
completionandthe
clienthasdemanded
theirreturn.
Accordingtotheprofessions
ethicalstandards,whichofthe
followingeventsmayjustifya
departurefromaStatementof
theGovernmentalAccounting
StandardsBoard?
New
legislation
No
Yes
Yes
No
Evolutionofanewform
ofbusinesstransaction
Yes
No
Yes
No
MayaCPAhirefortheCPAs
publicaccountingfirmanon
CPAsystemsanalystwho
specializesindeveloping
computersystems?
Yes, provided the CPA is
qualified to perform each of the
specialiststasks.
c.
No,becausenonCPA
professionals are not
permitted to be
associated with CPA
firms in public
d.
practice.
No,because
developingcomputer
systemsisnot
recognizedasa
serviceperformedby
publicaccountants.
10. StephanieSealsisaCPAwhoisworking
asacontrollerforBrentwoodCorporation.
Sheisnotinpublicpractice.Which
statementistrue?
a. ShemayusetheCPA
designationonher
businesscardsifshe
alsoputsher
employmenttitleon
them.
b. ShemayusetheCPA
designation on her
businesscardsaslong
as she does not
mention Brentwood
Corporationorhertitle
ascontroller.
c.
d.
11. Accordingtothestandardsof
theprofession,whichofthe
followingactivitieswouldmost
likelynotimpairaCPAs
independence?
a. Providingadvisoryservicesfora
client.
MODULE1PROFESSIONALRESPONSIBILITIES
b.
Contracting with a
clienttosupervisethe
clients
office
personnel.
Signing a clients checks in
emergencysituations.
Acceptingaluxuriousgiftfroma
client.
c.
12. Whichofthefollowingreports
may be issued only by an
accountantwhoisindependent
ofaclient?
a. Standardreportonan
examination of a
financialforecast.
b. Reportonconsultingservices.
c. Compilation report
on
historical
financial state
ments.
d. Compilationreportonafinancial
projection.
d.
c.
d.
13. Accordingtothestandardsof
theprofession,whichofthe
followingactivitiesmaybe
requiredinexercisingduecare?
a.
b.
c.
d.
Consulting
withexperts
Yes
Yes
No
No
Obtaining
specialtyaccreditation
Yes
No
Yes
No
14.LarrySampsonisaCPAandis
servingasanexpertwitnessinatrial
concerningacorporationsfinancialstate
ments.Whichofthefollowingis(are)
true?
I. Sampsonsstatusasanexpertwitness
isbaseduponhisspecialized
knowledge,experience,andtraining.
AI. Sampson is required by
AICPArulingtopresenthis
positionobjectively.
BI. Sampsonmayregardhimselfasacting
asanadvocate.
a.
b.
c.
d.
Ionly.
IandIIonly.
IandIIIonly.
IIIonly.
a.
apublishing
company.
Accepting
a
commissi
on for
recommen
ding a
productto
an audit
client.
Accepting
engagements
obtained
through the
efforts of
thirdparties.
c.
d.
Kars
friend,
an
employe
e of
another
local ac
counting
firm,
prepares
Forts
tax
returns.
Kars sibling is director of
internalauditatFort.
18. OnJune1,2008,aCPA
obtaineda$100,000personal
loanfromafinancialinstitution
clientforwhomtheCPA
providedcompilationservices.
Theloanwasfullysecuredand
consideredmaterialtothe
CPAsnetworth.TheCPApaid
theloaninfullonDecember31,
2009.OnApril3,2009,the
clientaskedtheCPAtoaudit
theclientsfinancialstatements
fortheyearendedDecember31,
2009.IstheCPAconsidered
independentwithrespecttothe
auditoftheclientsDecember
31,2009financialstatements?
a. Yes,becausetheloanwasfully
secured.
b. Yes, because
the CPA was
not required
to be inde
pendentatthe
time the loan
wasgranted.
c.
No,
becausethe
CPAhada
loan with
the client
during the
periodofa
professiona
l
engagemen
t.
d.
No,
because
the CPA
had a loan
with the
client
during the
period
coveredby
the
financial
state
ments.
19. Whichofthefollowing
statementsis(are)correctre
gardingaCPAemployeeofa
CPAfirmtakingcopiesof
informationcontainedinclient
fileswhentheCPAleavesthe
firm?
I.
ACPAleavingafirm
maytakecopiesof
informationcontained
inclientfilestoassist
anotherfirminserving
thatclient.
AI. ACPAleavingafirm
maytakecopiesof
informationcontained
inclientfilesasa
methodofgaining
technicalexpertise.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
NeitherInorII.
b.
Theaccountant
owns the
workingpapers
and generally
may disclose
them as the
accountantsees
fit.
Theclientownstheworking
papersbuttheaccountanthas
custodyofthemuntilthe
accountantsbillispaidinfull.
c. The
accountant
owns the
working
papers but
generally
may
not
disclosethem
without the
clients
consent or a
courtorder.
d. Theclient
ownsthe
working
papersbut,in
theabsence
ofthe
accountants
consent,may
notdisclose
themwithout
acourtorder.
21. Whichofthefollowingis
an authoritative body
designated to promulgate
attestationstandards?
a.
b.
c.
d.
AuditingStandardsBoard.
Governmental Accounting
StandardsBoard.
Financial Accounting Standards
Board.
GeneralAccountingOffice.
22. Accordingtotheprofessions
standards, which of the
followingwouldbeconsidered
consultingservices?
a.
b.
c.
d.
Advisory
services
Yes
Yes
Yes
No
Implementation
services
Yes
Yes
No
Yes
Product
services
Yes
No
Yes
Yes
MODULE1PROFESSIONALRESPONSIBILITIES
10
23.Accordingtothestandardsofthe
profession,whichofthefollowingevents
wouldrequireaCPAperforminga
consultingservicesengagementfora
nonauditclienttowithdrawfromthe
engagement?
I.
TheCPAhasaconflictof
interestthatisdisclosedtothe
clientandtheclientconsentsto
theCPAcontinuingthe
engagement.
AI. TheCPAfailstoobtain
awrittenunderstanding
from the client
concerningthescopeof
theengagement.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
NeitherInorII.
24. Whichofthefollowingservices
mayaCPAperformincarrying
out a consulting service for a
client?
I.
a.
b.
c.
d.
IandIIonly.
IandIIIonly.
IIandIIIonly.
I,II,andIII.
25. UndertheStatementsonStandardsfor
ConsultingServices,whichofthe
followingstatementsbestreflectsaCPAs
responsibilitywhenundertakinga
consultingservicesengagement?TheCPA
must
a. N
ot
se
ek
to
m
od
if
y
an
y
ag
re
e
m
en
t
m
ad
e
wi
th
th
b.
e
cli
en
t.
Notperformanyattestservicesfor
theclient.
c. I
n
f
o
r
m
t
h
e
cl
ie
n
t
o
f
si
g
n
if
ic
a
n
t
r
e
s
e
r
v
at
i
o
n
s
c
o
n
c
e
r
n
i
n
g
t
h
e
b
e
n
e
fi
ts
o
f
t
h
e
e
n
g
d.
a
g
e
m
e
nt
.
Obta
in a
writt
en
unde
rstan
ding
with
the
clien
t
con
cerni
ng
the
time
for
com
pleti
on
of
the
enga
gem
ent.
26. Whichofthefollowing
servicesisaCPAgenerally
requiredtoperformwhen
conductingapersonal
financialplanning
engagement?
a. Assi
sting
the
clien
t to
ident
ify
tasks
that
are
esse
ntial
in
order
to
act
on
plan
ning
decis
ions.
b. Assis
ting
the
client
to
take
actio
n on
c.
plann
ing
deci
sions.
Monitoringprogressinachieving
goals.
d. Upd
atin
g
reco
mm
end
atio
ns
and
revi
sing
plan
ning
deci
sion
s.
27. InrelationtotheAICPACodeof
Professional Conduct, the IFAC
Code of Ethics for Professional
Accountants
a. Hasmoreoutrightprohibitions.
b. Hasfeweroutrightprohibitions.
c. Hasnooutrightprohibitions.
d.
Applies
onl
y
to
pro
fes
sio
nal
acc
ou
nta
nts
in
bus
ine
ss.
28. BasedontheIFACCodeof
Ethicsfor
ProfessionalAccountants,
threatstoindependencearise
fromallofthefollowing
except:
a. Selfinterest.
b. Advocacy.
c. Theauditrelationship.
d. Intimidation.
29. Ifanauditfirmdiscoversthreats
toindependencewithrespectto
anauditengagement,theIFAC
CodeofEthicsforProfessional
Accountantsindicatesthatthe
firmshould
a.
b.
c.
30. Withrespecttotheacceptanceof
contingentfeesforprofessional
services,theIFACCodeofEthics
forProfessionalAccountants
indicatesthattheaccountingfirm
a.
Shouldnotacceptcontingentfees.
b. Should
establish
appropriate safeguards
aroundacceptanceofa
contingentfee.
c.
Should
accept
contingentfeesonlyfor
assurance services
other than audits of
financialstatements.
d.
Should
accept
contingentfeesifitis
customary in the
country.
31. Withregardtomarketing
professionalservices,theIFAC
CodeofEthicsforProfessional
Accountantsindicatesthat
a. Directmarketingisprohibited.
b. Marketingisallowediflawful.
c. Marketing should be honest and
truthful.
d. Marketing of audit services is
prohibited.
32. What body establishes international
auditingstandards?
a.
b.
c.
d.
33. Whichofthefollowingisnot
true about international
auditingstandards?
a.
b.
c.
d.
International auditing
standards do not
require an audit of
internalcontrol.
Internationalauditing
standardsdonotallow
referencetodivisionof
responsibilitiesinthe
auditreport.
International auditing
standards require
obtaining
an
attorneysletter.
International auditing
standardsarebasedona
risk
assessment
approach.
34. Whichofthefollowingisnot
true about international
auditingstandards?
a. Audit report modification for
consistencyintheapplicationof
accountingprinciplesisrequired.
b. Confirmation of
accounts
receivable is not
required.
c. The location in which
the auditor practices
mustbedisclosedinthe
auditreport.
d. International auditing
standards do not
require an audit of
internalcontrol.
35. Independencestandardsofthe
GAOforauditsinaccordance
withgenerallyaccepted
governmentauditingstandards
describethreetypesof
impairmentsofindependence.
Whichofthefollowingisnot
oneofthesetypesof
impairments?
a. Personal.
b. Organizational.
c. External.
d. Unusual.
36. Inaccordancewiththe
independencestandardsofthe
GAOforperformingauditsin
accordancewithgenerally
acceptedgovernmentauditing
standards,whichofthefol
MODULE1PROFESSIONALRESPONSIBILITIES
lowingisnotan
exampleofan
externalimpairment
ofindependence?
a. Redu
cing
the
exten
t of
audit
work
due
to
press
ure
from
mana
geme
nt to
reduc
e
audit
fees.
b. Sel
ecti
ng
aud
it
ite
ms
bas
ed
on
the
wis
hes
of
an
em
plo
yee
of
the
org
ani
zati
on
bei
ng
aud
ite
d.
c. Bias
in
the
item
sthe
audit
ors
deci
deto
selec
t for
testi
ng.
d.
11
Influenc
e
by
ma
nag
eme
nt
on
the
pers
onn
el
assi
gne
dto
the
aud
it.
37. Underthe
independence
standardsofthe
GAOforper
formingaudits
inaccordance
withgenerally
acceptedgov
ernment
auditing
standards,
whichofthe
followingare
overreaching
principlesfor
determining
whethera
nonaudit
serviceimpairs
independence?
I.
Audi
t
o
r
s
m
u
s
t
n
o
t
p
e
r
f
o
r
m
n
o
n
a
u
d
i
s
e
r
v
i
c
e
s
t
h
a
t
i
n
v
o
l
v
e
p
e
r
f
o
r
m
i
n
g
m
a
n
a
g
e
m
e
n
t
f
u
n
c
t
i
o
n
s
o
r
m
a
k
i
n
g
m
a
n
a
g
AI.
Audit
o
r
s
m
u
s
t
n
o
t
a
u
d
it
t
h
e
i
r
o
w
n
w
o
r
k
o
r
p
r
o
v
i
d
e
n
o
n
a
u
d
it
s
e
r
v
i
c
e
s
i
e
m
e
n
t
d
e
c
i
s
i
o
n
s
.
n
s
it
u
a
ti
o
n
s
i
n
w
h
i
c
h
t
h
e
n
o
n
a
u
d
it
s
e
r
v
i
c
e
s
a
r
e
s
i
g
n
i
f
i
c
a
n
t
o
r
m
a
t
e
r
i
a
l
t
o
t
h
e
s
u
b
j
e
c
t
matteroftheaudit.
BI.
Audi
t
o
r
s
m
u
s
t
n
o
t
p
e
r
f
o
r
m
n
o
n
a
u
d
i
t
s
e
r
v
i
c
e
s
w
h
i
c
h
r
e
q
u
i
r
e
i
n
d
e
p
e
n
d
e
n
c
e
.
a.
b.
c.
d.
Ionly.
IandIIonly.
I,IIandIII.
IIandIIIonly.
38. Whichofthe
following
bodies
enforce the
audit re
quirements
of the
Employee
Retirement
Security Act
of 1974
(ERISA)
with respect
to employee
benefit
plans?
a.
b.
c.
d.
TheDepartmentofLabor.
TheDepartmentofPensionManagement.
TheSecuritiesandExchangeCommission.
ThePublicCompanyAccountingOversightBoard.
39. Therequirement
for
independenceby
theauditorre
gardingauditsof
employee
benefitplans
applytotheplan
aswellas
a. In
ve
st
m
en
t
co
m
pa
ni
es
do
in
g
bu
si
ne
ss
wi
th
th
e
pl
an
.
b. Membersoftheplan.
c. Theplansponsor.
d. Theactuaryfirmdoingservicesfortheplan.
MODULE1PROFESSIONALRESPONSIBILITIES
12
SIMULATIONS
TaskBasedSimulation1
Independence
Issues
Authoritative
Literature
Help
Assumethatyouareanalyzingrelationshipsforyourfirmtoidentifysituationsinwhichanauditorsindependencemay
beimpaired.Foreachofthefollowingnumberedsituations,determinewhethertheauditor(acoveredmemberinthesituation)
isconsideredtobeindependent.IftheauditorsindependencewouldnotbeimpairedselectNo.Iftheauditorsindependence
wouldbeimpairedselectYes.
1.
2.
3.
4.
5.
T
h
T
6.
7.
8.
T
I
n
V
a
L
i
ThedirectoroftheauditcommitteeofHanmeiCorp.,anonissuer(nonpublic)company,hasindicatedthatthecompany
maybeinterestedinengagingyourfirmtoperformvariousprofessionalservices.Considereachofthefollowingpotential
servicesbyitself,anddeterminewhetheraCPAfirmmayprovidesuchaservice.IfaCPAfirmmayprovidetheservice,fillin
thecircleunderthefirstorsecondcolumnofrepliesbaseduponwhetherindependenceisrequired.Iftheservicemaynotbe
provided,fillinthecircleunderMayNotProvide.Foreachserviceyoushouldhaveonlyonereply.
1.
2.
Service
Provideanopiniononwhetherfinancialstatementsare
preparedfollowingthecashbasisofaccounting.
Compileaforecastforthecomingyear.
3.
4.
Applycertainagreeduponprocedurestoaccountsreceivable
forpurposesofobtainingaloan,andexpressasummaryof
findingsrelatingtothoseprocedures.
5.
Reviewquarterlyinformationandissueareportthatincludes
limitedassurance.
6.
Performanauditofthefinancialstatementsonwhether
they are prepared following generally accepted
accountingprinciples.
7.
Performareviewofaforecastthecompanyhasprepared
forthecomingyear.
Mayprovide,
independence
isrequired
Mayprovide,
independenceis
notrequired
May
notprovide
Service
8.
Compilethefinancialstatementsforthepastyear,butnotissue
areportsincethefinancialstatementsareonlyforthe
companysuse.
MODULE1PROFESSIONALRESPONSIBILITIES
13
Mayprovide,
independence
isrequired
Mayprovide,
independenceis
notrequired
May
notprovide
9.Calculatetheclientstaxesandfillouttheappropriatetax
forms.
10.DesignanewpayrollsystemforHanmeiandbasebillingson
Hanmeisactualsavingsforthenextthreeyears.
TaskBasedSimulation3
Research
Authoritative
Literature
Help
3.
Regardlessofwhatyoufind,hewouldlikeyoutodeterminewhetheracoveredmember
mayhavesuchanimmaterialfinancialinvestmentinanauditclient.Whattitle,
section,andparagraphaddressesthisissue?
TaskBasedSimulation4
ProvidingVarious
Services
Authoritative
Literature
Help
ThefirmofWillinghamandWhiting,CPAs,hashadrequestsfromanumberofclientsandprospectiveclientsasto
providingvarioustypesofservices.Pleasereplyastowhethertheappropriateindependencerules(AICPAand/orPCAOB)
allowthefollowingengagementswith
AAllowable,giventhesefacts.N
Notallowable,giventhesefacts.
14
(IfbothAICPAandPCAOBrulesapplyandoneofthemdoesnotallowtheservicesanswerN.)
MODULE1PROFESSIONALRESPONSIBILITIES
Case
Publicor
nonpublic
client
Request
1.
Provideinternalauditoutsourcingaswellasperformtheaudit.
Public
2.
Preparethecorporatetaxreturnaswellasperformtheaudit.
Public
3.
Preparethecorporatetaxreturnaswellasperformtheaudit.
Nonpublic
4.
Providebookkeepingservicesaswellasperformtheaudit;WWwillnot
determinejournalentries,authorizetransactions,prepareormodifysource
documents.
Nonpublic
5.
Providefinancialinformationsystemsdesignandimplementationassistance;
WWprovidesnoattestservicesforthatcompany.
Public
6.
Serveontheboardofdirectorsofthecompany;WWprovidesnoattest
servicesforthatcompany.
Public
7.
Implementanofftheshelfaccountingpackageaswellasperformtheaudit.
Nonpublic
8.
Provideactuarialservicesrelatedtocertainliabilitiesaswellasperformthe
audit;thesubjectivelydeterminedliabilitiesrelatetoamaterialportionofthe
financialstatements.
Nonpublic
9.
Provideactuarialservicesrelatedtocertainliabilitiesaswellasperformthe
audit;thesubjectivelydeterminedliabilitiesrelatetomaterialportionofthe
financialstatements.
Public
CorporateexecutivesofanauditclientwanttohaveWWprovidetaxplanning
forthemselves(notthecompany).
Public
10.
Allowable(A)
ornot
allowable
(NA)?
TaskBasedSimulation5
Research
Authoritative
Literature
Help
PayrollSystemEngagement
MichaelEdlingerispresidentofEdlingerCorporation,anonpublicmanufacturerofkitchencabinets.Hehasbeen
approachedbyMarlaWong,apartnerwithWongandCo.,CPAs,whosuggeststhatherfirmcandesignapayrollsystemfor
Edlingerthatwilleithersavehiscorporationmoneyorbefree.Morespecifically,Ms.Wongproposestodesignapayroll
systemforEdlingeronacontingentfeebasis.Shesuggeststhatherfirmsfeewillbe25%ofthesavingsinpayrollforeach
ofthenextfouryears.AfterfouryearsEdlingerwillbeabletokeepallfuturesavings.EdlingerCorporationspayrollsystem
costscurrentlyareapproximately$200,000annually,andthecorporationhasnotpreviouslybeenaclientofWong.Edlinger
CorporationisauditedbyanotherCPAfirmandWong&Co.providesnootherservicestoEdlingerCorporation.Selectone
ofthefollowingtopicstoanswerquestion1.
Selections
A. AU
B. PCAOB
C. AT
D.
AR
E.
ET
F. BL
G. CS
H. QC
1.
WhichtopicoftheProfessionalStandardsaddressesthisissueandwillbehelpful
indeterminingwhetherWong&Co.mayperformthisengagementunderthese
termswithoutviolatingprofessionalrequirements?
(A)(B)(C)(D)(E)(F)(G)(H)
2.
Providetheappropriateparagraphcitationthataddressesthisissue.
MODULE1PROFESSIONALRESPONSIBILITIES
3.
15
Interpretyourfindingsinparts1.and2.andconcludeonwhetherWong&Co.mayperformthisservicewithout
violatingprofessionalstandards.
___Yes,thisservicemaybeperformedwithoutviolatingprofessionalstandards.
___No,thisservicemaynotbeperformedwithoutviolatingprofessionalstandards.
TaskBasedSimulation6
Research
Authoritative
Literature
Help
ProfessionalStandards
YouhaveworkedwithJames&Co.CPAsforapproximately4months.JenJefferson,whohasjuststartedwithJames
&Co.,hasaskedyoutoexplainthenatureofvariousprofessionalstandardstoher.Morespecifically,shewouldliketo
haveabetterunderstandingofwhichstandardstoaddress,inwhichcircumstances.
Selecttheappropriatetitleofstandardsfor1.through10.below.Standardsmaybeselectedonce,morethanonce,ornot
at
all.
TitleofStandards
A. AICPABylaws(BL)
B. CodeofProfessionalConduct(ET)
C. PCAOBAuditingStandards
D. StandardsforPerformingandReportingonPeerReviews(PR)
E. StatementsonAuditingStandards(AU)
F. StatementsonQualityControlStandards(SQCS)
G. StatementsonStandardsforAccountingandReviewServices(SSARS)
H. StatementsonStandardsforAttestationEngagements(SSAE)
I. StatementsonStandardsforConsultingServices(CS)
J. StatementsonStandardsforTaxServices(TS)
8. For reporting on client pro forma
Standardsthatprovideguidance
financialinformation.
1.
2.
Onwhetheracontingentfeemaybebilledtoaclient.
3.
4.
RelatedtofirmrequirementsofCPAfirms
that are enrolled in an AICPAapproved
practicemonitoringsystem.
Foranexaminationofaclientsfinancialforecast.
5.
6.
Fortheauditofapubliccompany.
7.
Fortheperformanceofaninterimreviewof
the quarterly financial statements of a
nonpublicauditclient.
9.
(A)(B)(C)(D)(E)(F)(G)(H)(I)
(J)
MODULE1PROFESSIONALRESPONSIBILITIES
16
TaskBasedSimulation7
Research
Authoritative
Literature
Help
CodeofProfessionalConduct
AssumethatyouareemployedbyDFW,CPAs.Oneofthepartnershasaskedyoutoresearchtheprofessionalstandards
forthesectionthatidentifiestherequirementsregardingtheacceptanceofcontingentfeesforengagements.
Titlechoices
A. AU
B. PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
(A)(B)(C)(D)(E)(F)(G)(H)
1.
WhichtitleoftheProfessionalStandardsaddressesthisissueandwillbe
helpfulinrespondingtothepartner?
2.
Entertheexactsectionandparagraphswithhelpfulinformation.
MODULE1
PROFESSIONALRESPONSIBILITIES
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
7.
8.
9.
C
D
B
C
C
A
D
C
B
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
10.
11.
12.
13.
14.
15.
16.
17.
18.
a
a
a
b
b
c
a
d
b
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
19.
20.
21.
22.
23.
24.
25.
26.
27.
d
c
a
a
d
d
c
a
b
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
17
28. c
29. d
30. b
31. c
32. b
33. c
34. a
35. d
36. c
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
37. b
38. a
39. c
1st:
2nd:
__ __
__ __
__ __
__/39=__%
__/39=__%
MULTIPLECHOICEANSWEREXPLANATIONS
A.1.3.CodeofProfessionalConduct
1.(c)Therequirementistoidentifythestatementthatbest
describesthemeaningofgenerallyacceptedauditing
standards.Answer(c)iscorrectbecausegenerally
acceptedauditingstandardsdealwithmeasuresofthe
qualityoftheperformanceofauditprocedures(AU150).
Answer(d)isincorrectbecauseproceduresrelatetoactsto
beperformed,notdirectlytothestandards.Answer(b)is
incorrectbecausegenerallyacceptedauditingstandards
havebeenissuedbypredecessorgroups,aswellasbythe
AuditingStandardsBoard.Answer(a)isincorrectbecause
theremayormaynotbeuniversalcompliancewiththe
standards.
2.
(d)Allofthesecanresultintheautomaticexpulsionof
thememberfromtheAICPA.Answer(a)isincorrect
becausealthoughtheconvictionofafelonycanresultin
automaticexpulsion,likewisecantheothertwo.An
swers(b)and(c)areincorrectbecauseallthreecanresult
inautomaticexpulsionfromtheAICPA.
3.
(b)Answer(b)iscorrectbecauseaneffective
corporategovernancestructureisacontrolthat
canbeimplementedbyaclientthatincreases
independenceoftheattestteam.Answer(a)is
incorrectbecauseitisasafeguardthatis
implementedbyregulationortheCPAfirm.
Answer
(c)isincorrectbecauseitisasafeguardthatisrequiredby
regulationortheCPAfirm.Answer(d)isincorrect
becauseitrepresentsathreatratherthanasafeguard.
4.
(c)Answer(c)iscorrectbecausetheteam
memberwouldbereviewinghisorherown
work.Answer(a)isincorrectbecausethisisan
exampleofafamiliaritythreat.Answer(b)is
incorrectbecausethisisanexampleofa
safeguardtothreatstoindependence.Answer
(d)isincorrectbecausethisrepresentsa
financialselfinterestthreattoindependence.
5.
(c)AccordingtotheCodeofProfessional
Conduct,Rule101regardingindependence,a
spousemaybeemployedbyaclientifs/hedoes
notexertsignificantinfluenceoverthecontents
oftheclientsfinancialstatements.Thisisakey
positionasdefinedbytheInterpretationofRule
101.
6.
(a)AccordingtoRule102oftheCodeofProfes
sionalConduct,inperforminganyprofessional
service,amembershallmaintainobjectivityand
integrity,avoidconflictsofinterest,andnot
knowinglymisrepresentfacts.Answer(a)is
correctasthiswouldbeknowinglymisrepre
sentingthefacts.Answers(b)and(d)are
incorrectasthese
arenotintentionalmisstatements.Answer(c)isincorrect
becausewhileonemustremainobjectivewhile
performingconsultingservices,independenceisnot
requiredunlesstheCPAalsoperformsattestservicesfor
thatclient.
7.
(d)Therequirementistodeterminewhichactisgenerally
prohibited.Answer(d)iscorrectbecauseIfan
engagementisterminatedpriortocompletion,themember
isrequiredtoreturnonlyclientrecords(ET501).Answer
(a)isincorrectbecauseissuingamodifiedreport
explainingafailuretofollowagovernmentalregulatory
agencysstandardswhenconductinganattestserviceis
notprohibited.Answer(c)isincorrectbecauseacceptinga
contingentfeeisallowablewhenrepresentingaclientin
anexaminationbyarevenueagentoftheclientsfederal
orstateincometaxreturn(ET302).Answer(b)is
incorrectbecauserevealingconfidentialclientinformation
duringaqualityreviewofaprofessionalpracticebya
teamfromthestateCPAsocietyisnotprohibited(ET
301).
8.
(c)AccordingtoRule203oftheCodeof
ProfessionalConduct,CPAsareallowedto
departfromaGASBStatementonlywhen
resultsoftheStandardwouldbemisleading.
Examplesofpossiblecircumstancesjustifying
departurearenewlegislationandanewformof
businesstransaction.
9.
(b)Therequirementistodeterminewhethera
CPAmayhireanonCPAsystemsanalystand,
ifso,underwhatconditions.Answer(b)is
correctbecauseET291allowssuchasituation
whentheCPAisqualifiedtosuperviseand
evaluatetheworkofthespecialist.Answer(a)is
incorrectbecausetheCPAneednotbequalified
toperformthespecialiststasks.Answer(c)is
incorrectbecausenonCPAprofessionalsare
permittedtobeassociatedwithCPAfirmsin
publicpractice.Answer(d)isincorrectbecause
nonprofessionalsmaybehired,andbecause
developingcomputersystemsisrecognizedasa
serviceperformedbypublicaccountants.
10. (a)ShemayusetheCPAdesignationonher
businesscardswhenshedoesnotimply
independencebutshowshertitleandher
employer.Therefore,answer(b)isincorrect.
Answer(c)isincorrectbecauseshemayusethe
CPAdesignationonherbusinesscardsor
companytransmittalsifshedoesnotimply
independence.Answer(d)isincorrectbecause
undertheabovesituations,shecanusetheCPA
designation.
11. (a)Therequirementistodeterminetheactivity
that would most likely not impair a CPAs
independence.Ac
*
Explanationofhowtousethisperformancerecordappearsonpage2.
18
MODULE1PROFESSIONALRESPONSIBILITIES
countingandconsultingservicesdonot
normallyimpairindependencebecause
themembersroleisadvisoryinnature
(ET191).Answers(b)and(c)are
incorrectbecausemanagementfunctions
arebeingperformed(ET191).Answer
(d)isincorrectbecauseacceptinga
luxuriousgiftimpairsaCPAs
independence(ET191).
specializedknowledge,
training,andexperience.
15. (c)Therequirementistodeterminewhich
actisgenerallyprohibited.Answer(c)is
correctbecauseamemberinpublic
practiceshallnotforacommissionrec
ommendorrefertoaclientanyproductor
service,orforacommissionrecommendor
referanyproductorservicetobesupplied
byaclient,orreceiveacommissionwhen
thememberorthemembersfirmperform
forthatclient:(1)anauditofafinancial
statement;or(2)acompilationofafi
nancialstatementwhenthemember
expectsthatathirdpartywillusethe
financialstatementandthemembers
compilationreportdoesnotdisclosealack
ofindependence;or(3)anexaminationof
prospectivefinancialinformation.Answer
(a)isincorrectbecauseamembermay
purchaseaproductandresellittoaclient.
Anyprofitonsalewouldnotconstitutea
commission(ET591).
12. (a)Therequirementistoidentifythetype
ofreportthatmaybeissuedonlybyan
independentaccountant.Answer(a)is
correctbecauseAT101requiresan
accountantbeindependentforall
attestationengagements.Anattestation
engagementisoneinwhichtheaccountant
expressesaconclusionaboutthereliability
ofassertionswhicharetheresponsibilityof
anotherparty.Astandardreportonan
examinationofafinancialforecastrequires
theauditortoexpressanopinion,which
requiresanaccountanttobeindependent.
16. (a)Theprincipleofduecarerequiresthe
Answer(b)isincorrectbecauseCS100
membertoobservetheprofessions
indicatesthatconsultingservicesare
technicalandethicalstandards,strive
fundamentallydifferentfromtheattestation
continuallytoimprovecompetenceandthe
function,andthereforedonotrequire
qualityofservices,anddischarge
independenceoftheaccountant.Answers
responsibilitytothebestofthemembers
(c)and(d)areincorrectbecauseAR100
ability.Answer(b)isincorrectasthe
indicatesthatanaccountantwhoisnot
auditorisnotrequiredtoexamineall
independentisnotprecludedfromissuinga
reportonacompilationoffinancial
corroboratingevidencesupporting
statements.
managementsassertions,butratherto
examineevidence
13. (b)PerET56,duecarerequires
amembertodischarge
professionalresponsibilitieswith
competenceanddiligence.
Competencerepresentsthe
attainmentandmaintenanceofa
levelofunderstandingand
knowledgethatenablesa
membertorenderserviceswith
facilityandacumen.Italso
establishesthelimitationsofa
memberscapabilitiesby
dictatingthatconsultationor
referralmayberequiredwhena
professionalengagementexceeds
thepersonalcompetenceofa
memberoramembersfirm.
Accordingly,answer(b)is
correctasitmayberequiredto
consultwithexpertsin
exercisingduecare.Duecare
doesnotrequireobtaining
specialtyaccreditation.
14. (b)Underruling101underRule
ofConduct102,whenaCPAis
actingasanexpertwitness,s/he
shouldnotactasanadvocate
butshouldgivehis/herposition
basedonobjectivity.Theexpert
witnessdoesthisbasedon
onascopebasisbasedonhis/her
considerationofmaterialityandlevelof
riskassessed.Answer(c)isincorrectasthe
auditorshouldbeawareofthepossibility
ofillegalacts,butanauditprovidesno
assurancethatalloranyillegalactswillbe
detected.Answer(d)isnotthebestanswer
becausecompetenceisderivedfromboth
educationandexperience.Theprincipleof
duecarerequiresthemembertostriveto
improvecompetence,however,attaining
theproperbalanceofprofessional
experienceandformaleducationisnota
criterionforexercisingduecare.
17. (d)Thefactthatacloserelative
ofKarworksforFortimpairs
Karsindependence.Answer(a)
isincorrectbecausethegiftisofa
tokenamountwhichdoesnot
impairKarsindependence.
Answer(b)isincorrectbecausea
jointfinancialinvestmentmustbe
materialtoimpairindependence,
andthiswouldgenerallynot
occurwithrespecttoaretirement
plan.Answer(c)isincorrect
becausepreparationoftheclients
taxreturnisnotaservicethat
impairsindependence.
incorrectbecausestatementII
alsoisincorrect.Answer(c)is
incorrectbecausestatementsI
andIIarebothincorrect.
20. (c)InformationintheCPAs
workingpapersisconfidential
andmaynotbedisclosedexcept
withtheclientsconsentorby
courtorder.Answer(a)is
incorrectbecausedisclosureof
theinformationwouldgenerally
violateRule301onconfidential
clientinformation.Answers(b)
and(d)areincorrectbecausethe
CPAownstheworkingpapers.
21. (a)Therequirementistoidentify
thelistedauthoritativebody
designatedtopromulgate
attestationstandards.Answer(a)
iscorrectbecauseonlythe
AuditingstandardsBoard,the
AccountingandReviewServices
Committee,andtheManagement
AdvisoryServicesExecutive
Committeehavebeenauthorized
topromulgateattestation
standards.
A.4.ResponsibilitiesinConsulting
Services
18. (b)Independencewasnotrequiredatthe
22. (a) Types of consulting
timetheloanwasobtained,andbecauseit
servicesincludeconsultations,
isfullysecureditisgrandfatheredby101
advisory
services,
5.Answer(a)isincorrectbecauseifthe
implementation services,
CPAisrequiredtobeindependent,a
transactionservices,staffand
mortgageloanwouldnotbepermittedeven
other support services, and
ifitwasfullysecured.Answer(c)is
productservices.
incorrectbecausetheCPAwasnotrequired
tobeindependentoftheclient.Answer(d) 23. (d)AccordingtotheStatementsonStandards
isincorrectbecausetheCPAwasnot
forConsultingServices,independenceisnot
requiredtobeindependentoftheclient.
requiredforperformanceofconsulting
19. (d)Bothofthestatementsare
incorrect;eitherwouldviolate
Rule301onconfidentialclient
information.Answer(a)is
incorrectbecausestatementIalso
isincorrect.Answer(b)is
servicesunlesstheCPAalsoperformsattest
servicesforthatclient.However,theCPA
mustremainobjectiveinperformingthe
consultingservices.Furthermore,the
understandingwiththeclientforperforming
theservicescanbeestablishedeitherin
writingororally.
MODULE1PROFESSIONALRESPONSIBILITIES
24. (d)CS100indicatesthatthe
natureandscopeofconsulting
servicesisdeterminedsolelyby
thepractitionerandtheclient,
typicallyinwhichthe
practitionerdevelopsfindings,
conclusions,and
recommendationsfortheclient.
Allthreeserviceslistedwould
fallunderthedefinitionof
consultingservices.
identifythecharacteristicthat
differsbetweenthetwosetsof
ethicalstandards.Answer(b)
iscorrectbecausetheIFAC
Codehasfeweroutright
prohibitionsthantheAICPA
Code.Answers(a)and(c)are
incorrectbecausetheIFAC
Codehasfeweroutright
prohibitions.Answer(d)is
incorrectbecausetheIFAC
Codeappliestoallprofessional
accountants.
19
Definingengagementobjectives
21. Planning specific procedures
appropriatetoengagement
22.
Developing basis for
recommendations
23.
Communicatingrecommendations
toclient
24. Identifying tasks for taking
actiononplanningdecisions.
Otherengagementsmayalsoinclude,but
generallyarenotrequiredtoperform,
thefollowing:
1.
2.
Assisting client to
take action on
planningdecisions
Monitoring clients progress in
achievinggoals
3. Updating
recommendations and
helping client revise
planningdecisions.
D. InternationalStandardsEthical
27. (b)Therequirementisto
Auditing/Assurance
Standards
32. (b)Therequirementistoidentifythebody
thatestablishesinternationalauditing
standards.Answer(b)iscorrectbecause
theInternationalAuditingandAssurance
StandardsBoardoftheInternational
FederationofAccountantsestablishes
internationalauditingstandards.Answer
(a)isincorrectbecausethePublic
CompanyAccountingOversightBoard
establishesstandardsfortheauditofpublic
companiesintheUS.Answers(c)and(d)
areincorrectbecausethesebodiesdonot
establishauditingstandards.
33. (c)Therequirementistoidentify
theitemthatisnottrueabout
internationalauditingstandards.
Answer(c)iscorrectbecause
internationalauditingstandards
requireobtaininganattorneys
letteronlyiftheauditorsassessa
riskofmaterialmisstatement.
Answers(a),(b)and(d)are
incorrectbecausetheyareall
trueaboutinternationalauditing
standards.
34. (a)Therequirementistoidentify
theitemthatisnottrueabout
internationalauditingstandards.
Answer(a)iscorrectbecause
internationalauditingstandards
donotrequireamodificationof
theauditreportforconsistency
intheapplicationofaccounting
principles.Answers(b),(c),and
(d)areincorrectbecausetheyare
trueaboutinternationalauditing
standards.
F.2.GovernmentAccountabilityOffice
(GAO)
35. (d)Therequirementistoidentify
theimpairmentthatisnotoneof
thethreetypesofimpairments
describedintheGAOstandards.
Answer(d)iscorrectbecausean
unusualimpairmentisnotoneof
thetypesofimpairments
describedintheGAOstandards.
Answers(a),(b)and(c)are
incorrectbecausetheyarethe
threetypesofimpairments
describedintheGAOstandards.
36. (c)Therequirementistoidentify
theexamplethatdoesnot
representanexternalimpairment
ofindependence.Answer(c)is
correctbecausethisitemisan
exampleofapersonal
impairmentofindependence.
Answers(a),(b)and
(d) are incorrect because they are all
examples of external impairments of
independence.
37. (b)Therequirementistoidentify
theoverreachingprinciplesfor
identifyingwhethernonaudit
servicesimpairindependence.
Answer(b)iscorrectbecauseI
andIIarethetwoprinciples.
Answer(a)isincorrectbecauseII
isalsoan
MODULE1PROFESSIONALRESPONSIBILITIES
20
overreachingprinciple.Answer(c)isincorrectbecauseIIIisnotanoverreachingprinciple.
Answer(d)isincorrectbecauseIisanoverreachingprincipleandIIIisnot.
F.3.DepartmentofLabor(DOL)
38. (a)TherequirementistoidentifythebodythatenforcestheauditrequirementsofERISA.
Answer(a)iscorrectbecausetheDepartmentofLaborisresponsibleforenforcingtheaudit
requirements.Answer(b)isincorrectbecausetheDepartmentofPensionManagementdoes
notexist.Answers(c)and(d)areincorrectbecausetheSECandthePCAOBdealwith
auditingrequirementsforentitieswithpubliclytradedsecurities(issuers).
39. (c)Therequirementistoidentifythepartythatindependencestandardsalsoapply
towhenperforminganauditofanemployeebenefitplan.Answer(c)iscorrect
becausetheDepartmentofLaborrulesalsoapplytoindependencefromtheplanand
theplansponsor.Answers(a),(b)and(d)areincorrectbecausetheindependence
standardsdonotapplytotheseparties.
MODULE1PROFESSIONALRESPONSIBILITIES
21
SOLUTIONSTOSIMULATIONS
TaskBasedSimulation1
Independence
Issues
Authoritative
Literature
Help
Yes
1.
Theauditorisacosignerofaclientschecks.
2.
Theauditorisamemberofacountryclubwhichisaclient.
3.
Theauditorownsalargeblockofstockinaclientbuthasplaceditinablindtrust.
4.
Theauditorplacedhercheckingaccountinabankwhichisherclient.Theaccountisfully
insuredbyafederalagency.
5.
Theclienthasnotpaidtheauditorforservicesforthepasttwoyears.
6.
Theauditorisleasingpartofhisbuildingtoaclient.
7.
Theauditorjoins,asanordinarymember,atradeassociationwhichisalsoaclient.
8.
Theauditorhasanimmaterial,indirectfinancialinterestintheclient.
Explanationofsolutions
1.
2.
(Y)Sincetheauditorisacosigneronaclientscheck,theauditorcouldbecome
liable if the client defaults. This relationship impairs the auditors
independence.
(N)Independenceisnotimpairedbecausemembershipinthecountryclubisessentially
asocialmatter.
3.
(Y)Anauditormaynotholdadirectfinancialinterestinaclient.Puttingitina
blindtrustdoesnotsolvetheimpairmentofindependence.
4.
(N)Iftheauditorplaceshis/heraccountinaclientbank,thisdoesnotimpair
independenceiftheaccountsarestateorfederallyinsured.Iftheaccountsare
notinsured,independenceisnotimpairediftheamountsareimmaterial.
5.
(Y)Theauditorsindependenceisimpairedwhenprioryearsfeesforprofessional
servicesremainunpaidformorethanoneyear.
6.
(Y) Theauditorsindependenceisimpairedwhens/heleasesspaceoutofabuilding
s/heownstoaclient.
7.
(N)Whentheauditordoesnotserveinmanagement,s/hemayjoinatradeassociation
No
whoisaclient.
8.
(N)Independenceisimpairedfordirectfinancialinterestsandmaterial,indirect
financialinterestsbutnotforimmaterial,indirectfinancialinterests.
TaskBasedSimulation2
Independenceand
VariousServices
Authoritative
Literature
Help
1.
2.
Service
Provide an opinion on whether
financial statements are prepared
followingthecashbasisofaccounting
Compileaforecastforthecomingyear.
3.
Compilethefinancialstatementsforthe
pastyearandissueapubliclyavailable
report.
4.
Applycertainagreeduponproceduresto
accountsreceivableforpurposesof
obtainingaloan,andexpressasummaryof
findingsrelatingtothoseprocedures.
5.
Mayprovide,
independence
isrequired
Mayprovide,
independenceis
notrequired
May
notprovide
MODULE1PROFESSIONALRESPONSIBILITIES
22
6.
7.
8.
Service
Perform an audit of the financial
statements on whether they are
preparedfollowinggenerallyaccepted
accountingprinciples.
Perform a review of a forecast the
companyhaspreparedforthecoming
year.
Compilethefinancialstatementsforthepast
year,butnotissueareportsincethe
financialstatementsareonlyforthe
companysuse.
Mayprovide,
independence
isrequired
Mayprovide,
independenceis
notrequired
May
notprovide
9.Calculatetheclientstaxesandfillouttheappropriatetax
forms.
10. DesignanewpayrollsystemforHanmeiandbasebillingson
Hanmeisactualsavingsforthenextthreeyears.
TaskBasedSimulation3
Research
Authoritative
Literature
Help
1.
Hethinksthatherecallstheissuerelatestowhetheryouareorarenota
coveredmember.Hewouldlikeyoutofindthedefinitionofacovered
memberintheprofessionalstandards.WhichtitleoftheProfessionalStan
dardsaddressesthisissueandwillbehelpfulinrespondingtothesenior?
2.
Entertheexactsectionandparagraphswithhelpfulinformation.
92
06
3.
Regardlessofwhatyoufind,hewouldlikeyoutodeterminewhetheracoveredmember
mayhavesuchanimmaterialfinancialinvestmentinanauditclient.Whattitle,section,
andparagraphaddressesthisissue?
ET
101
02
TaskBasedSimulation4
ProvidingVarious
Services
Authoritative
Literature
Help
1.
Notallowable(PCAOBrequirementsprohibit)
2.
Allowable
3.
Allowable
4.
Allowable
5.
Allowable(Becausenoattestservicesareprovided,thePCAOPallowsthis)
6.
Notallowable
7.
Allowable
8.
Notallowable(AICPArulesprohibitthiswhenamountsaresubjectivelydetermined
andmaterial)
9.
Not allowable (Both AICPA nor PCAOB rules prohibit this when amounts are
subjectivelydeterminedandmaterial)
10. Notallowable
MODULE1PROFESSIONALRESPONSIBILITIES
23
TaskBasedSimulation5
Research
Authoritative
Literature
Help
1. WhichtopicoftheProfessionalStandardsaddressesthisissueandwillbe
helpfulindeterminingwhetherWong&Co.mayperformthisengagement
underthesetermswithoutviolatingprofessionalrequirements?
2. Providetheappropriateparagraphcitationthataddressesthisissue.
3.
302
01
Interpretyourfindingsinparts1and2andconcludeonwhetherWong&Co.
mayperformthisservicewithoutviolatingprofessionalstandards.
_x_Yes,thisservicemaybeperformedwithoutviolatingprofessionalstandards.
___ No,thisservicemaynotbeperformedwithoutviolatingprofessional
standards.
TaskBasedSimulation6
Research
Authoritative
Literature
Help
Standardsthatprovideguidance
1. Forperformanceofareviewofanonpubliccompanysannualfinancial
statements.
2. Onwhetheracontingentfeemaybebilledtoaclient.
3. RelatedtofirmrequirementsofCPAfirmsthatareenrolledinan
AICPAapprovedpracticemonitoringsystem.
4. Foranexaminationofaclientsfinancialforecast.
5. Relatingtooverallrequirementswhenprovidingservicesforan
advisoryservicesengagement.
6. Fortheauditofapubliccompany.
7. Fortheperformanceofaninterimreviewofthequarterlyfinancial
statementsofanonpublicauditclient.
8. Forreportingonclientproformafinancialinformation.
9. OnwhetheraninvestmentofaCPAimpairsherindependencewith
respecttoaclient.
10. Onperformingacompilationofanonpubliccompanysquarterly
statements.
TaskBasedSimulation7
Research
Authoritative
Literature
Help
1. WhichtitleoftheProfessionalStandardsaddressesthisissueandwillbe
helpfulinrespondingtothepartner?
2. Entertheexactsectionandparagraphswithhelpfulinformation.
(A)(B)(C)(D)(E)(F)(G)(H)
302
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
24
ENGAGEMENTPLANNING,OBTAININGANUNDERSTANDING
OFTHECLIENTANDASSESSINGRISKS
6.Financialstatementassertionsare
establishedforaccountbalances,
MULTIPLECHOICEQUESTIONS(1113)
d.
a.
b.
c.
d.
4.
Whichofthefollowingismostlikely
tobeuniquetotheauditworkof
CPAsascomparedtowork
performedbypractitionersofother
professions?
Dueprofessionalcare.
Competence.
Independence.
Complexbodyofknowledge.
The third general standard states
that duecare is to be exercised in
the performance of an audit. This
standardisordinarilyinterpretedto
require
a. Thorough review of the
existing safeguards over
access to assets and
records.
b. Limited review of the
a.
b.
c.
d.
7.
Classesoftransactions
Yes
Yes
No
No
Disclosures
Yes
No
Yes
No
a.
Completeness.
8.
Astheacceptablelevelofdetection
riskdecreases,anauditormay
b.
c.
d.
Existence.
Rightsandobligations.
Valuationandcompetence.
c.
d.
5.
d.
indicationsofemployee
fraudandillegalacts.
Objective review of the
adequacy of the technical
trainingandproficiencyof
firmpersonnel.
Critical review of the
judgment exercised at
everylevelofsupervision.
Afterfieldworkauditproceduresare
completed,apartneroftheCPA
firmwhohasnotbeeninvolvedin
theauditperformsasecondorwrap
upworkingpaperreview.This
secondreviewusuallyfocuseson
a. Thefairpresentationofthe
financial statements in
conformitywithGAAP.
b. Fraud involving the
clients management and
itsemployees.
c. The materiality of the
adjustingentriesproposed
bytheauditstaff.
The communication of internal
control weaknesses to the clients
auditcommittee.
a.
c.
d.
9.
a.
b.
c.
d.
Theriskthatanauditorwillconclude,
basedonsubstantivetests,thata
materialmisstatementdoesnotexist
inanaccountbalancewhen,infact,
suchmisstatementdoesexistis
referredtoas
Samplingrisk.
Detectionrisk.
Nonsamplingrisk.
Inherentrisk.
10. Astheacceptablelevelofdetection
riskdecreases,theassurancedirectly
providedfrom
a. Substantivetestsshouldincrease.
b. Substantivetestsshoulddecrease.
c. Testsofcontrolsshouldincrease.
d. Testsofcontrolsshoulddecrease.
11. Which of the following audit risk
components may be assessed in
nonquantitativeterms?
a.
b.
c.
d.
Controlrisk
Yes
Yes
Yes
No
Detectionrisk
Yes
No
Yes
Yes
Inherentrisk
No
Yes
Yes
Yes
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
overallauditrisklevelthatissubstantially
thesameastheplannedauditrisklevel,the
auditorwould
a. Decreasesubstantivetesting.
b. Decreasedetectionrisk.
c. Increaseinherentrisk.
d. Increasematerialitylevels.
14. Relationship between control risk
anddetectionriskisordinarily
a. Parallel.
b. Inverse.
c. Direct.
d. Equal.
15. Whichofthefollowingwouldan
auditormostlikelyuseindetermining
theauditorspreliminaryjudgment
aboutmateriality?
a. The anticipated sample size of the
plannedsubstantivetests.
b. The entitys annualized
interim financial state
ments.
c. The results of the internal control
questionnaire.
d. The contents of the
management representation
letter.
16. Whichofthefollowingstatementsis
notcorrectaboutmateriality?
a. Theconceptofmateriality
recognizesthatsomematters
areimportantforfair
presentationoffinancial
statementsinconformity
withGAAP,whileother
mattersarenotimportant.
b. Anauditorconsiders
materialityforplanning
purposesintermsofthe
largestaggregatelevelof
misstatementsthatcouldbe
materialtoanyoneofthe
financialstatements.
c.
Materialityjudgmentsare
madeinlightofsur
roundingcircumstances
andnecessarilyinvolve
bothquantitativeand
qualitativejudgments.
d.
Anauditorsconsideration
ofmaterialityisinfluenced
bytheauditorsperception
oftheneedsofareasonable
personwhowillrelyonthe
financialstatements.
17. Whichofthefollowingelements
underliestheapplicationof
generallyacceptedauditing
standards,particularlythestandards
offieldworkandreporting?
a. Internalcontrol.
b.
c.
d.
Corroboratingevidence.
Qualitycontrol.
Materialityandrelativerisk.
25
18. Inconsideringmaterialityfor
planningpurposes,anauditor
believesthatmisstatements
aggregating$10,000wouldhavea
materialeffectonanentitysincome
statement,butthatmisstatements
wouldhavetoaggregate$20,000to
materiallyaffectthebalancesheet.
Ordinarily,itwouldbeappropriateto
designauditingproceduresthat
wouldbeexpectedtodetect
misstatementsthataggregate
a. $10,000
b. $15,000
c. $20,000
d. $30,000
19. Whichofthefollowingwouldan
auditormostlikelyusein
determiningtheauditorspreliminary
judgmentaboutmateriality?
a. Theresultsoftheinitialassessmentof
controlrisk.
b.
c.
20. Holdingotherplanningconsiderationsequal,a
decreaseintheamountofmisstatementina
classoftransactionsthatanauditorcould
toleratemostlikelywouldcausetheauditorto
a. Apply the planned
substantivetestspriorto
thebalancesheetdate.
b. Perform the planned
auditing procedures closer
tothebalancesheetdate.
c. Increase the assessed level
ofcontrolriskforrelevant
financial
statement
assertions.
d. Decrease the extent of
auditingprocedurestobe
applied to the class of
transactions.
21. Whenissuinganunqualifiedopinion,
the auditor who evaluates the audit
findingsshouldbesatisfiedthatthe
a.
b.
c.
d.
Amount of known
misstatement
is
documented in the
management representation
letter.
Estimate of the total
likely misstatement is
less than a material
amount.
Amount of known
misstatement
is
acknowledged
and
recordedbytheclient.
c.
d.
Estimateofthetotallikelymisstatement
includestheadjustingentriesalready
recordedbytheclient.
Reasonableassurance.
Supervision.
c.
d.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
26
Errors
Yes
Yes
Yes
No
Fraudulent
financialreporting
Yes
Yes
No
Yes
Misappropriation
ofassets
Yes
No
Yes
No
29.Anauditorisunabletoobtainabsolute
assurancethatmisstatementsduetofraudwill
bedetectedforallofthefollowingexcept
a. Employeecollusion.
b. Falsifieddocumentation.
c. Need to apply professional
judgment in evaluating
fraudriskfactors.
d. Professionalskepticism.
30. The most difficult type of
misstatement to detect is fraud
basedon
a. Theoverrecordingoftransactions.
b. Thenonrecordingoftransactions.
c. Recordedtransactionsinsubsidiaries.
d. Relatedpartyreceivables.
31. Whenconsideringfraudrisk
factorsrelatingtomanagements
characteristics,whichofthe
followingisleastlikelytoindicate
ariskofpossiblemisstatementdue
a.
c.
tofraud?
Failure to correct known reportable
conditionsonatimelybasis.
b. Nonfinancial
managements
preoccupation with the
selection of accounting
principles.
Significantportionofmanagements
compensationrepresentedbybonuses
baseduponachievingunduly
aggressiveoperatingresults.
d. Use of unusually
conservative accounting
practices.
a.
b.
c.
d.
Computergenerateddocuments.
Missingdocuments.
Yearendadjustingjournalentries.
33. Whichofthefollowingismost
likelytobearesponsetothe
auditorsassessmentthattheriskof
materialmisstatementduetofraud
fortheexistenceofinventoryis
high?
a. Observe test counts of
inventoryatcertainloca
tionsonanunannounced
basis.
b. Perform
analytical
procedures rather than
takingtestcounts.
c. Requestthatinventoriesbe
countedpriortoyearend.
d.
34. Whichofthefollowingismostlikely
tobeanexampleoffraud?
a. Defalcations occurring
duetoinvalidelectronic
approvals.
b. Mistakes in the
applicationofaccounting
principles.
c. Mistakesinprocessingdata.
d. Unreasonable accounting
estimates arising from
oversight.
d.
personnelislow.
b. Insiders recently purchased
additional shares of the
entitysstock.
c. Management places
substantial emphasis
on meeting earnings
projections.
The rate of change in the entitys
industryisslow.
Anauditorisnotresponsible
fordetectingmisstatements
duetoerrorsandfraud
unlesstheapplicationof
GAASwouldresultinsuch
detection.
d.
Anauditorshoulddesign
theaudittoproviderea
sonableassuranceof
detectingmisstatementsdue
toerrorsandfraudthatare
materialtothefinancial
statements.
35. Whichofthefollowing
characteristicsmostlikelywould
37. Disclosureoffraudtopartiesotherthana
heightenanauditorsconcern
clientsseniormanagementanditsaudit
abouttheriskofintentional
committeeorboardofdirectorsordinarilyis
manipulationoffinancial
notpartofanauditorsresponsibility.
statements?
However,towhichofthefollowingoutside
a. Turnover of senior accounting
partiesmayadutytodisclosefraudexist?
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
27
conditionsrelatingtofinancialstressof
employeesoradverserelationshipsbetweena
companyanditsemployees?
Toagovernment
a. Theauditorisrequiredto
TotheSEC
Toasuccessor
fundingagency
plan the audit to detect
whenthe
auditorwhenthe fromwhichthe
these conditions on all
clientreports successormakes
clientreceives
anauditor
appropriate
financial
audits.
change
inquiries
assistance
b. Theseconditionsrelateto
a.
Yes
Yes
No
fraudulentfinancialre
b.
Yes
No
Yes
porting,andanauditoris
c.
No
Yes
Yes
requiredtoplantheauditto
d.
Yes
Yes
Yes
detecttheseconditions
whentheclientisexposed
38. Under Statements on Auditing
toariskofmisappropriation
Standards, which of the following
ofassets.
wouldbeclassifiedasanerror?
c.
Theauditorisrequiredto
a. Misappropriation of assets
plantheaudittodetect
for the benefit of man
theseconditionswhenever
agement.
theymayresultinmis
b. Misinterpretation
by
statements.
management of facts that
d.
The auditor is not required
existed whenthe financial
toplantheaudittodiscover
statementswereprepared.
theseconditions,butshould
c. Preparation of records
consider them if he or she
byemployeestocovera
becomes aware of them
fraudulentscheme.
duringtheaudit.
d. Intentionalomissionofthe
recording of a transaction
tobenefitathirdparty.
39. What assurance does the auditor
provide that misstatements due to
errors,fraud,anddirecteffectillegal
actsthatarematerialtothefinancial
statementswillbedetected?
a.
b.
c.
d.
Errors
Limited
Limited
Reasonable
Reasonable
Fraud
Negative
Limited
Limited
Reasonable
Directeffect
illegalacts
Limited
Reasonable
Limited
Reasonable
40. Becauseoftheriskofmaterial
misstatement,anauditoffinancial
statementsinaccordancewith
generallyacceptedauditing
standardsshouldbeplannedand
performedwithanattitudeof
a. Objectivejudgment.
b. Independentintegrity.
c. Professionalskepticism.
d. Impartialconservatism.
41. Which of the following most
accurately summarizes what is
meant by the term material
misstatement?
a. Fraudanddirecteffectillegalacts.
b. Fraud involving senior
management and material
fraud.
c. Material error, material
fraud, and certain illegal
acts.
d. Material error and material illegal
acts.
42. Whichofthefollowingstatementsbest
describestheauditorsresponsibilitytodetect
43. Whentheauditorbelievesa
misstatementisormaybetheresult
offraudbutthattheeffectofthe
misstatementisnotmaterialtothe
financialstatements,whichofthe
followingstepsisrequired?
a. Consider the implications
for other aspects of the
audit.
b. Resignfromtheaudit.
c. Commenceafraudexamination.
d. Contactregulatoryauthorities.
44. Whichofthefollowingstatementsis
correct relating to the auditors
considerationoffraud?
a. Theauditorsinterestinfraud
considerationrelatestofraudulentacts
thatcauseamaterialmisstatementof
financialstatements.
b. A primary factor that
distinguishesfraudfromer
ror is that fraud is always
intentional,whileerrorsare
generally, but not always,
intentional.
c.
d.
Whileanauditorshouldbeawareof
thepossibilityoffraud,management,
andnottheauditor,isresponsiblefor
detectingfraud.
45. Whichofthefollowingfactors
orconditionsisanauditorleast
likely to plan an audit to
discover?
a. Financial pressures affecting
employees.
b. Highturnoverofseniormanagement.
c. Inadequate monitoring of significant
controls.
d. Inability to generate
positive cash flows from
operations.
Planning
Yes
Yes
Yes
No
Obtaining
Understanding
Yes
Yes
No
Yes
Conducting
fieldwork
Yes
No
No
Yes
47. Managementsattitudetoward
aggressivefinancialreportingandits
emphasisonmeetingprojectedprofit
goalsmostlikelywouldsignificantly
influenceanentityscontrol
environmentwhen
a. Externalpoliciesestablished
bypartiesoutsidetheentity
affect its accounting
practices.
b. Management is dominated
by one individual who is
alsoashareholder.
c. Internalauditorshavedirect
access to the board of
directors and the entitys
management.
d. The audit committee is active in
overseeing the entitys financial
reportingpolicies.
48. Whichofthefollowingisleastlikely
toberequiredonanaudit?
a. Test appropriateness of
journal entries and adjust
ment.
b. Review accounting estimates for
biases.
c. Evaluate the business
rationaleforsignificantun
usualtransactions.
d. Make a legal
determination of whether
fraudhasoccurred.
49. Which of the following is most
likelytobeanoverallresponseto
fraudrisksidentifiedinanaudit?
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
28
d.
a.
b.
Supervisemembersofthe
auditteamlesscloselyand
relymoreuponjudgment.
Uselesspredictableauditprocedures.
c. Onlyusecertifiedpublic
accountants on the en
gagement.
d.
Placeincreasedemphasison
the audit of objective
transactions rather than
subjectivetransactions.
50. Whichofthefollowingisleast
likelytobeincludedinanauditors
inquiryofmanagementwhile
obtaininginformationtoidentifythe
risksofmaterialmisstatementdueto
fraud?
a. Are financial reporting
operations controlled by
and limited to one
location?
b. Does it have knowledge of fraud or
suspectfraud?
c. Does it have programs to mitigate
fraudrisks?
d. Hasitreportedtotheaudit
committeethenatureofthe
companysinternalcontrol?
51. Individualswhocommitfraudare
ordinarily able to rationalize the
actandalsohavean
a.
b.
c.
d.
Incentive
Yes
Yes
No
No
Opportunity
Yes
No
Yes
No
Smallhighdollarinventoryitems.
54. Whichofthefollowingismostlikely
tobepresumedtorepresentfraudrisk
onanaudit?
a. Capitalization of repairs
and maintenance into the
property, plant, and
equipmentassetaccount.
b. Improperrevenuerecognition.
c. Improperinterestexpenseaccrual.
d. Introduction of significant new
products.
55. Anauditorwhodiscoversthata
clientsemployeespaidsmall
bribestomunicipalofficialsmost
likelywouldwithdrawfromthe
engagementif
a. The payments violated the
clients policies regarding
the prevention of illegal
acts.
b. Theclientreceivesfinancial
assistance from a federal
governmentagency.
c. Documentation that is
necessarytoprovethatthe
bribeswerepaiddoes not
exist.
d. Management fails to take
the appropriate remedial
action.
56. Whichofthefollowingfactorsmost
likely would cause a CPA to not
acceptanewauditengagement?
a.
b.
c.
d.
clients
operationandindustry.
The CPA is unable to
review the predecessor
auditorsworkingpapers.
The prospective client is
unwilling to make all fi
nancial records available
totheCPA.
c.
d.
Violationsofantitrustlaws.
Pricefixing.
60. Whichofthefollowingrelatively
smallmisstatementsmostlikelycould
haveamaterialeffectonanentitys
financialstatements?
a. An illegal payment to a
foreign official that was
notrecorded.
b. Apieceofobsoleteoffice
equipment that was not
retired.
c. A petty cash fund
disbursement that was not
properlyauthorized.
d. An uncollectible account
receivable that was not
writtenoff.
57. Whichofthefollowingfactors
wouldmostlikelyheightenan
auditorsconcernabouttheriskof
fraudulentfinancialreporting?
a. Large amounts of liquid
61. DuringtheannualauditofAjaxCorp.,a
assets that are easily con
publiclyheldcompany,Jones,CPA,a
vertibleintocash.
continuingauditor,determinedthatillegal
b. Low growth and
politicalcontributionshadbeenmadeduring
profitabilityascomparedto
eachofthepastsevenyears,includingtheyear
other entities in the same
underaudit.Jonesnotifiedtheboardof
industry.
directorsabouttheillegalcontributions,but
c. Financial managements
theyrefusedtotakeanyactionbecausethe
participation in the initial
amountsinvolvedwereimmaterialtothe
selection of accounting
financialstatements.Jonesshouldreconsider
principles.
theintendeddegreeofreliancetobeplacedon
d. An overly complex
the
organizational structure
a. Letterofauditinquirytotheclients
involving unusual lines of
attorney.
authority.
b. Prioryearsauditprograms.
58. Anauditorwhodiscoversthata
clientsemployeeshavepaidsmall
bribestopublicofficialsmostlikely
wouldwithdrawfromthe
engagementifthe
a. Client receives financial
assistance from a federal
governmentagency.
b. Evidence thatisnecessary
toprovethattheillegalacts
were committed does not
exist.
c. Employeesactionsaffect
the auditors ability to
rely on managements
representations.
d. Notes to the financial
statements fail to disclose
theemployeesactions.
59. Whichofthefollowingillegalacts
should an audit be designed to
obtain reasonable assurance of
detecting?
a.
Securities purchased by
relatives of management
based on knowledge of
insideinformation.
b.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
c.
d.
Managementrepresentationletter.
Preliminary judgment about
materialitylevels.
62. Themostlikelyexplanationwhythe
auditorsexaminationcannot
reasonablybeexpectedtobringall
illegalactsbytheclienttothe
auditorsattentionisthat
a. Illegalactsareperpetrated
by management override
ofinternalcontrol.
b. Illegalactsbyclientsoften
relatetooperatingaspects
rather than accounting
aspects.
c. Theclientsinternalcontrol
maybesostrongthatthe
auditorperformsonly
minimalsubstantive
testing.
d. Illegal acts may be
perpetrated by the only
person in the clients
organizationwithaccessto
both assets and the
accountingrecords.
63. Ifspecificinformationcomestoan
auditorsattentionthatimpliesthe
existenceofpossibleillegalactsthat
couldhaveamaterial,butindirect
effectonthefinancialstatements,
theauditorshouldnext
a. Apply audit procedures
specifically directed to as
certaining whether an
illegalacthasoccurred.
b. Seek the advice of an
informedexpertqualifiedto
practice law astopossible
contingentliabilities.
c.
d.
64. Anauditorwhodiscoversthat
clientemployeeshavecommitted
anillegalactthathasamaterial
effectontheclientsfinancial
statementsmostlikelywould
withdrawfromtheengagementif
a. The illegal act is a
violation of generally
accepted accounting
principles.
b. The client does not take
the remedial action that
the auditor considers
c.
d.
29
necessary.
The illegal act was
committed during a prior
yearthatwasnotaudited.
The auditor has already
assessed control risk at the
maximumlevel.
65. UnderthePrivateSecurities
LitigationReformActof1995,
Baker,CPA,reportedcertain
uncorrectedillegalactsto
Supermartsboardofdirectors.Baker
believedthatfailuretotakeremedial
actionwouldwarrantaqualified
auditopinionbecausetheillegalacts
hadamaterialeffectonSupermarts
financialstatements.Supermartfailed
totakeappropriateremedialaction
andtheboardofdirectorsrefusedto
informtheSECthatithadreceived
suchnotificationfromBaker.Under
thesecircumstances,Bakerisre
quiredto
a. Resign from the audit
engagementwithintenbusi
nessdays.
b. Deliver a report
concerningtheillegalacts
to the SEC within one
businessday.
c. Notify the stockholders
that the financial state
ments are materially
misstated.
d. Withholdanauditopinion
until Supermart takes
appropriate remedial
action.
66. Whichofthefollowingwouldbeleastlikelyto
beconsideredanauditplanningprocedure?
a.
b.
c.
d.
Useanengagementletter.
Developtheoverallauditstrategy.
Performriskassessment.
Developtheauditplan.
67. Whichofthefollowingfactorswould
mostlikelycauseaCPAtodecidenot
toacceptanewauditengagement?
a.
b.
c.
d.
auditors
computerassisted audit
techniques.
Managementsdisregardof
itsresponsibilitytomaintain
anadequateinternalcontrol
environment.
TheCPAsinabilityto
determinewhetherrelated
partytransactionswere
consummatedonterms
equivalenttoarmslength
transactions.
Managementsrefusalto
permit the CPA to per
form substantive tests
beforetheyearend.
b.
c.
predecessorhadwiththe
clientconcerningauditing
proceduresandaccounting
principles.
The predecessors evaluation of
matters of continuing accounting
significance.
d.
The
predecessors
assessmentsofinherentrisk
and judgments about
materiality.
70. Beforeacceptinganaudit
engagement,asuccessorauditor
shouldmakespecificinquiriesof
thepredecessorauditorregarding
thepredecessors
a. Opinionofanysubsequent
events occurring since the
predecessors audit report
wasissued.
b. Understanding as to the
reasons for the change of
auditors.
c. Awareness of the
consistency in the
application of GAAP
betweenperiods.
d. Evaluationofallmattersof
continuing accounting
significance.
71. Anauditorisrequiredtoestablishan
understandingwithaclientregarding
theservicestobeperformedforeach
engagement.Thisunderstanding
generallyincludes
a. Managements
responsibilityforerrorsand
the illegal activities of
employees that may cause
materialmisstatement.
b. The
auditors
responsibilityforensuring
thattheauditcommitteeis
aware of any significant
deficiencies in internal
control that come to the
auditorsattention.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
30
c.
d.
Managements
responsibilityfor
providingtheauditorwith
anassessmentoftherisk
ofmaterialmisstatement
duetofraud.
Theauditorsresponsibilityfor
determiningpreliminaryjudgments
aboutmaterialityandauditrisk
factors.
about
materiality.
c. Managements vicarious
liability for illegal acts
committed by its
employees.
d. The
auditors
responsibilitytosearchfor
significant internal
controldeficiencies.
73. During the initial planning phase
of an audit, a CPA most likely
would
a. Identify specific internal
control activities that are
likelytopreventfraud.
b. Evaluate
the
reasonableness of the
clients accounting
estimates.
c. Discuss the timing of the
audit procedures with the
clientsmanagement.
d. Inquire of the clients
attorneyastowhetherany
unrecorded claims are
probableofassertion.
74. Whichofthefollowingstatements
would least likely appear in an
auditorsengagementletter?
a. Fees for our services are
based on our regular per
diem rates, plus travel and
other outofpocket ex
penses.
b. Duringthecourseofour
auditwemayobserveop
portunitiesforeconomyin,
orimprovedcontrolsover,
youroperations.
c. Ourengagementissubject
totheriskthatmaterial
misstatementsorfraud,if
d.
theyexist,willnotbe
detected.
Afterperformingour
preliminaryanalytical
procedureswewilldiscuss
withyoutheotherproce
duresweconsidernecessary
tocompletetheen
gagement.
CPA
responsibilities
Yes
Yes
Yes
No
Client
responsibilities
Yes
No
No
No
Limitationof
engagement
Yes
Yes
No
No
factoryequipment.
77. Arrangementsconcerningwhichof
81. ACPAwishestodeterminehowvarious
thefollowingare least likelytobe
publiclyheldcompanieshavecompliedwith
includedinengagementletter?
thedisclosurerequirementsofanewfinancial
a. Apredecessorauditor.
accountingstandard.Whichofthefollowing
b. Feesandbilling.
informationsourceswouldtheCPAmostlikely
c. CPAinvestmentinclientsecurities.
consultforinformation?
d. Other services to be provided in
a. AICPA Codification of
additiontotheaudit.
Statements on Auditing
Standards.
78. Theauditorshoulddocumentthe
b. AICPA Accounting Trends and
understandingestablishedwitha
Techniques.
clientthrougha(n)
c.
SECQualityControlReview.
a. Oralcommunicationwiththeclient.
b.
c.
d.
79. Whichofthefollowingfactorsmost
likelywouldinfluenceanauditors
determination of the auditability of
anentitysfinancialstatements?
a. The complexity of the accounting
system.
b. The existence of relatedparty
transactions.
c. The adequacy of the accounting
records.
d. Theoperatingeffectivenessofcontrol
procedures.
80. Whichofthefollowingismostlikely
to require special planning
considerations related to asset
valuation?
a. Inventory is comprised of diamond
rings.
b. The client has recently
purchased an expensive
copymachine.
c. Assets costing less than
$250 are expensed even
when the expected life
exceedsoneyear.
d. Accelerateddepreciationmethodsare
used for amortizing the costs of
d.
SECStatement10KGuide.
82. Anauditorshoulddesignthewrittenaudit
programso
that
a. All material transactions
will be selected for sub
stantivetesting.
b. Substantivetestspriorto
the balance sheet date
willbeminimized.
c. The audit procedures selected will
achievespecificauditobjectives.
d. Eachaccountbalancewill
be tested under either
testsofcontrolsortestsof
transactions.
83. The audit program usually cannot be
finalizeduntilthe
a.
b.
c.
d.
Consideration of the
entitys internal control
hasbeencompleted.
Engagement letter has
beensignedbytheauditor
andtheclient.
Reportable conditions have
been communicated to the
audit committee of the
boardofdirectors.
Search for unrecorded
liabilitieshasbeenper
formed
and
documented.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
c.
84. Auditprogramsshouldbedesignedsothat
a. Most of the required
procedures can be
performedasinterimwork.
b. Inherent risk is assessed at a
sufficientlylowlevel.
c. The auditor can make
constructivesuggestionsto
management.
d. Theauditevidencegathered
supports the auditors
conclusions.
85. Indesigningwrittenauditprograms,
anauditorshouldestablishspecific
auditobjectivesthatrelateprimarily
tothe
a. Timingofauditprocedures.
b. Costbenefitofgatheringevidence.
c. Selectedaudittechniques.
d. Financialstatementassertions.
86. With respect to planning an audit,
whichofthefollowingstatementsis
alwaystrue?
a. Itisacceptabletoperforma
portion of the audit of a
continuing audit client at
interimdates.
b. An engagement should
notbeacceptedafterthe
clientsyearend.
c. Aninventorycountmustbeobserved
atyearend.
d. Finalstaffingdecisions
mustbe made prior to
completion of the
planningstage.
87. Theelementoftheauditplanningprocessmost
likelytobeagreeduponwiththeclientbefore
implementationoftheauditstrategyisthe
determinationofthe
a. Evidencetobegatheredto
provide a sufficient basis
fortheauditorsopinion.
b. Procedures to be
undertaken to discover
litigation, claims, and
assessments.
c. Pendinglegalmatterstobe
included in the inquiry of
theclientsattorney.
d. Timing of inventory
observation procedures to
beperformed.
88. Toobtainanunderstandingofa
continuing clients business, an
auditormostlikelywould
a. Perform tests of details
of transactions and bal
ances.
b. Reviewprioryearworking
papersandthepermanent
filefortheclient.
d.
Readcurrentissues
of specialized
industryjournals.
Reevaluate the clients
internal control environ
ment.
31
89. Onanauditengagementperformed
byaCPAfirmwithoneoffice,atthe
minimum,knowledgeoftherelevant
professionalaccountingandauditing
standardsshouldbeheldby
a. The auditor with final responsibility
fortheaudit.
b. All professionals working upon the
audit.
c. Allprofessionalsworking
upon the audit and the
partner in charge of the
CPAfirm.
d. All professionals working in the
office.
90. An auditor obtains knowledge
aboutanewclientsbusinessand
itsindustryto
a. Make constructive
suggestions concerning
improvements to the
clientsinternalcontrol.
c.
d.
Understandtheeventsand
transactionsthatmayhavean
effectontheclients
financialstatements.
91. Whichofthefollowingprocedures
wouldanauditorleastlikely
performwhileobtainingan
understandingofaclientina
financialstatementaudit?
a. Coordinatingtheassistance
ofentitypersonnelindata
preparation.
b. Discussingmattersthatmay
affecttheauditwithfirm
personnelresponsiblefor
nonauditservicestothe
entity.
c. Selecting a sample of
vendorsinvoicesforcom
parison to receiving
reports.
d. Reading thecurrentyears
interim financial state
ments.
92. Ordinarily,thepredecessorauditorpermitsthe
successorauditortoreviewthepredecessors
workingpaperanalysesrelatingto
a.
b.
c.
d.
thatStarsprioryearsfinancial
statements,whichwereauditedby
Tell,requiresubstantialrevisions.
Underthesecircumstances,Land
should
a. NotifyStarsaudit
committeeandstockholders
thattheprioryears
financialstatementscannot
bereliedon.
Evaluatewhetherthe
aggregationofknownmis
statementscausesthe
financialstatementstakenas
awholetobematerially
misstated.
Contingencies
Yes
Yes
No
No
b.
c.
d.
94. Asuccessorauditorshouldrequest
the new client to authorize the
predecessor auditor to allow a
reviewofthepredecessors
a.
b.
c.
d.
Engagementletter
Yes
Yes
No
No
Workingpapers
Yes
No
Yes
No
95.Whichofthefollowingprocedureswouldan
auditormostlikelyperforminplanninga
financialstatementaudit?
Balancesheetaccounts
Yes
No
Yes
No
93. Inauditingthefinancialstatementsof
StarCorp.,Landdiscovered
informationleadingLandtobelieve
RequestStartoreissuethe
prior years financial
statements with the
appropriaterevisions.
Notify Tell about the information and
make inquiries about the integrity of
Starsmanagement.
a.
b.
c.
d.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
32
b.
d.
control
weaknesses.
c. Relatedpartytransactions.
d. Recordedtransactionsthat
were not properly au
thorized.
47. Whichofthefollowingnonfinancial
informationwouldanauditormost
likelyconsiderinperforming
analyticalproceduresduringthe
planningphaseofanaudit?
a. Turnoverofpersonnelin
the accounting depart
ment.
b. Objectivity of audit committee
members.
c. Squarefootageofsellingspace.
d. Managements plans to repurchase
stock.
48. The incharge auditor most likely
would have a supervisory
responsibilitytoexplaintothestaff
assistants
a. That immaterial fraud is
not to be reported to the
clientsauditcommittee.
b. How the results of various auditing
procedures performed by the
assistantsshouldbeevaluated.
c. What benefits may be
attainedbytheassistants
adherence to established
timebudgets.
d. Whycertaindocumentsare
being transferred from the
current file to the
permanentfile.
49. The audit work performed by each
assistant should be reviewed to
determinewhetheritwasadequately
performed and to evaluate whether
the
a. Auditorssystemofquality
control has been main
tainedatahighlevel.
b. Results are consistent
c.
d.
withtheconclusionstobe
presentedintheauditors
report.
Audit
procedures
performed are approved
in the professional
standards.
Audithasbeenperformed
bypersonshavingade
quatetechnicaltraining
andproficiencyasaudi
tors.
50. Whileassessingtherisksof
materialmisstatementauditors
identifyrisks,relaterisktowhat
couldgowrong,considerthe
magnitudeofrisksand
a. Assesstheriskofmisstatementsdue
toillegalacts.
b. Considerthecomplexity
of the transactions in
volved.
c. Consider the likelihood
thattheriskscouldresult
inmaterialmisstatements.
d. Determinematerialitylevels.
51. Whichofthefollowingare
consideredfurtherauditprocedures
thatmaybedesignedafterassessing
therisksofmaterialmisstatement?
a.
b.
c.
d.
Substantive
testsofdetails
Yes
Yes
No
No
Riskassessment
procedures
Yes
No
Yes
No
103. Whichofthefollowingisleastlikely
to be considered a risk assessment
procedure?
a. Analyticalprocedures.
b. Confirmation of ending accounts
receivable.
c. Inspectionofdocuments.
d. Observation of the
performance of certain
accountingprocedures.
104. In an audit of a nonissuer
(nonpublic)company,theauditors
identify significant risks. These
risksoften
a. Involve routine, highvolume
transactions.
b. Donotrequirespecialauditattention.
c. Involve items with lower levels of
inherentrisk.
d. Involvejudgmentalmatters.
105. Theauditorwithfinalresponsibility
foranengagementandoneofthe
assistantshaveadifferenceof
opinionabouttheresultsofan
auditingprocedure.Iftheassistant
believesitisnecessarytobe
disassociatedfromthematters
resolution,theCPAfirms
proceduresshouldenablethe
assistantto
a. Refer the disagreement
to the AICPAs Quality
ReviewCommittee.
b. Documentthedetailsofthe
disagreement with the
conclusionreached.
c. Discuss the disagreement with the
entitys management or its audit
committee.
d. Report the disagreement
to an impartial peer re
viewmonitoringteam.
106. An examination of a financial
forecastisaprofessionalservice
thatinvolves
a. Compiling or assembling a financial
forecast that is based on
managementsassumptions.
b. Limiting the distribution of
the accountants report to
management and the board
ofdirectors.
c. Assuming responsibility to
updatemanagementonkey
eventsforoneyearafterthe
reportsdate.
d. Evaluatingthepreparation
ofafinancialforecastand
thesupportunderlying
managementsassump
tions.
107. The nature and extent of a CPA
firms quality control policies and
proceduresdependon
a.
b.
c.
d.
TheCPA
firmssize
Yes
Yes
Yes
No
Thenature
oftheCPA
firmspractice
Yes
Yes
No
Yes
Costbenefit
considerations
Yes
No
Yes
Yes
108.ACPAfirmmaycommunicateitsquality
controlpoliciesandprocedurestoitspersonnelin
whichmanner(s):
a.
b.
c.
d.
Orally
No
No
Yes
Yes
Written
No
Yes
No
Yes
109.Whichofthefollowingisnotan
elementofqualitycontrol?
a. Acceptanceandcontinuanceofclient
relationships and specific
engagements.
b. Humanresources.
c. Internalcontrol.
d. Monitoring.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
110. Quality control for a
CPAfirm,asreferredto
in Statements on
Quality
Control
Standards,appliesto
a. Auditingservicesonly.
b. Auditingandmanagementadvisoryservices.
c. Auditingandtaxservices.
d. Auditingandaccountingandreviewservices.
111. OneofaCPAfirms
basicobjectivesisto
provideprofessional
servicesthatconform
withprofessionalstan
dards.Reasonable
assuranceofachieving
thisbasicobjectiveis
providedthrough
a. Asystemofqualitycontrol.
b. Asystemofpeerreview.
c. Continuingprofessionaleducation.
d. Complianc
e with
generally
accepted
reporting
standards.
112. Whichofthefollowing
is correct concerning
PCAOB guidance that
usesthetermshould?
a. Theauditormustfulfilltheresponsibilities.
b.
Theauditor
mustcomply
with
requirements
unlesss/he
demonstrates
thatalternative
actionswere
sufficientto
achievethe
objectivesof
thestandard.
c.
Theauditor
should
consider
performing
the
procedure;
whetherthe
auditor
performs
dependson
theexercise
of
professional
judgmentin
the
circumstance
s.
The auditor
has complete
d.
33
discretion as
to whether to
perform the
procedure.
113. Whichofthefollowing
setsofstandardsdoesthe
PublicCompany
AccountingOversight
Boardnothavetheau
thoritytoestablishfor
auditsofpublic
companies?
a. Auditingstandards.
b. Qualitycontrolstandards.
c. Accountingstandards.
d. Independencestandards.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
34
SIMULATIONS
TaskBasedSimulation1
AuditRisk
Application
Authoritative
Literature
Help
Green,CPA,isconsideringauditrisk,includingfraudrisk,atthefinancialstatementlevelinplanningtheauditofNational
FederalBank(NFB)CompanysfinancialstatementsfortheyearendedDecember31,2005.Auditriskatthefinancialstate
mentlevelisinfluencedbytheriskofmaterialmisstatements,whichmaybeindicatedbyacombinationoffactorsrelatedto
management,theindustry,andtheentity.InassessingsuchfactorsGreenhasgatheredthefollowinginformationconcerning
NFBsenvironment.
Companyprofile
NFBisafederallyinsuredbankthathasbeenconsistentlymoreprofitablethantheindustryaveragebymarketingmort
gagesonpropertiesinaprosperousruralarea,whichhasexperiencedconsiderablegrowthinrecentyears.NFBpackagesits
mortgagesandsellsthemtolargemortgageinvestmenttrusts.Despiterecentvolatilityofinterestrates,NFBhasbeenableto
continuesellingitsmortgagesasasourceofnewlendablefunds.
NFBsboardofdirectorsiscontrolledbySmith,themajoritystockholder,whoalsoactsasthechiefexecutiveofficer.
ManagementatthebanksbranchofficeshasauthorityfordirectingandcontrollingNFBsoperationsandiscompensatedbased
onbranchprofitability.TheinternalauditorreportsdirectlytoHarris,aminorityshareholder,whoalsoactsaschairmanofthe
boardsauditcommittee.
TheaccountingdepartmenthasexperiencedlittleturnoverinpersonnelduringthefiveyearsGreenhasauditedNFB.
NFBsformulaconsistentlyunderestimatestheallowanceforloanlosses,butitscontrollerhasalwaysbeenreceptiveto
Greenssuggestionstoincreasetheallowanceduringeachengagement.
Recentdevelopments
During2005,NFBopenedabranchofficeinasuburbantownthirtymilesfromitsprincipalplaceofbusiness.Although
thisbranchisnotyetprofitableduetocompetitionfromseveralwellestablishedregionalbanks,managementbelievesthatthe
branchwillbeprofitableby2007.Also,during2005,NFBincreasedtheefficiencyofitsaccountingoperationsbyinstallinga
new,sophisticatedcomputersystem.
Basedonlyontheinformationabove,indicatebymarkingtheappropriatebuttonwhetherthefollowingfactorsindicatean
increasedordecreasedauditrisk.Also,indicatewhetherthefactorisafraudriskfactor.
Factor
1. Branchmanagementauthority
Increasedauditrisk
Decreasedauditrisk
Fraudriskfactor
2. Governmentregulation
3. Companyprofitability
4. Demandforproduct
5. Interestrates
6. Availabilityofmortgagefunds
7. Involvementofprincipalshareholderin
Management
8. Branchmanagercompensation
9. Internalauditreportingrelationship
10. Accountingdepartmentturnover
11. Continuingauditrelationship
12.Internalcontrolsoveraccountingestimates
13.Responsetoproposedaccounting
Adjustments
14. Newunprofitablebranch
15. Newcomputersystem
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
35
TaskBasedSimulation2
RiskofMaterial
Authoritative
Misstatement
Literature
Help
Green,CPA,isconsideringauditrisk,includingfraudrisk,atthefinancialstatementlevelinplanningtheauditofNational
FederalBank(NFB)CompanysfinancialstatementsfortheyearendedDecember31,2005.Auditriskatthefinancialstate
mentlevelisinfluencedbytheriskofmaterialmisstatements,whichmaybeindicatedbyacombinationoffactorsrelatedto
management,theindustry,andtheentity.InassessingsuchfactorsGreenhasgatheredthefollowinginformationconcerning
NFBsenvironment.
Companyprofile
NFBisafederallyinsuredbankthathasbeenconsistentlymoreprofitablethantheindustryaveragebymarketingmort
gagesonpropertiesinaprosperousruralarea,whichhasexperiencedconsiderablegrowthinrecentyears.NFBpackagesits
mortgagesandsellsthemtolargemortgageinvestmenttrusts.Despiterecentvolatilityofinterestrates,NFBhasbeenableto
continuesellingitsmortgagesasasourceofnewlendablefunds.
NFBsboardofdirectorsiscontrolledbySmith,themajoritystockholder,whoalsoactsasthechiefexecutiveofficer.
ManagementatthebanksbranchofficeshasauthorityfordirectingandcontrollingNFBsoperationsandiscompensatedbased
onbranchprofitability.TheinternalauditorreportsdirectlytoHarris,aminorityshareholder,whoalsoactsaschairmanofthe
boardsauditcommittee.
TheaccountingdepartmenthasexperiencedlittleturnoverinpersonnelduringthefiveyearsGreenhasauditedNFB.
NFBsformulaconsistentlyunderestimatestheallowanceforloanlosses,butitscontrollerhasalwaysbeenreceptiveto
Greenssuggestionstoincreasetheallowanceduringeachengagement.
Recentdevelopments
During2005,NFBopenedabranchofficeinasuburbantownthirtymilesfromitsprincipalplaceofbusiness.Although
thisbranchisnotyetprofitableduetocompetitionfromseveralwellestablishedregionalbanks,managementbelievesthatthe
branchwillbeprofitableby2007.Also,during2005,NFBincreasedtheefficiencyofitsaccountingoperationsbyinstallinga
new,sophisticatedcomputersystem.
Assumeyouarepreparingfortheauditpersonneldiscussionofpotentialrisksofmaterialmisstatementduetofraudfor
theNFBaudit.Whileanymattersbelowmightbediscussed,indicatebymarkingtheappropriatefourhighestrisksbasedon
theinformationcontainedinthesimulationdescriptionandrequirementsofprofessionalstandards.
Risk
Highriskitem
1. Computerfraudrisk
2. Riskrelatedtomanagementoverrideofinternalcontrol
3. Fraudbybranchmanagement
4. Fraudbyaccountingpersonnel
5. Misstatementofaccountingestimates
6. Fraudbyloanprocessingclerks
7. Fraudbyinternalauditors
8. Theriskoffraudulentmisstatementofrevenues
TaskBasedSimulation3
Research
Topics
Authoritative
Literature
Help
AssumethatyouhavebeenhiredtoperformtheauditofHanmeisfinancialstatements.Whenplanningsuchanaudit,you
oftenmayneedtorefertovariousoftheprofessionsauditingstandards.ForeachofthefollowingcircumstancesinColumnA,
selectthetopicfromtheProfessionalStandardsthatislikelytoprovidethemostguidanceintheplanningoftheaudit.Atopic
maybeselectedonce,morethanonce,ornotatall.
A.
B.
C.
D.
E.
Topic
AnalyticalProcedures
AuditRiskandMateriality
CommunicationsbetweenPredecessorandSuccessor
Auditors
ConsiderationofFraudinaFinancialStatementAudit
UnderstandingtheEntityandItsEnvironmentand
F. IllegalActsbyClients
G. ManagementRepresentations
H. PartoftheAuditPerformedbyOtherIndependent
Auditors
I. RelatedParties
AssessingtheRisksofMaterialMisstatement
36
1.
2.
3.
4.
5.
6.
7.
8.
9.
T
r
P
T
h
H
C
o
A
u
R
e
A
u
T
h
D
10. T
h
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
TaskBasedSimulation4
Risk
Analysis
Authoritative
Literature
Help
DietWebInc.(hereafterDietWeb)wasincorporatedandbeganbusinessinMarchof20X1,
sevenyearsago.Youareworkingonthe20X8audityourCPAfirmsfifthauditofDietWeb.
Thecompanysmissionistoprovidesolutionsthathelpindividualstorealizetheirfullpotential
throughbettereatinghabitsandlifestyles.Muchof20X1and20X2wasspentindevelopingaunique
softwareplatformthatfacilitatestheproductionofindividualizedmealplansandshoppinglistsusing
aspecificmathematicalalgorithm,whichconsiderstheusersphysicalcondition,proclivityto
exercise,foodpreferences,cookingpreferences,desiretouseprepackagedmealsordineout,among
others.DietWebsolditsfirstonlinedietprogramin20X2andhascontinuedtomarketmemberships
throughincreasingonlineadvertisingarrangementsthroughtheyears.Thecompanyhascontinuedto
developthisprogramthroughouttheyearsandfinallybecameprofitablein20X6.
DietWebisexecutingastrategytobealeadingonlineproviderofservices,informationand
productsrelatedtonutrition,fitnessandmotivation.In20X8,thecompanyderivedapproximately86%
ofitstotalrevenuesfromthesaleofapproximately203,000personalizedsubscriptionbasedonline
nutritionplansrelatedtoweightmanagement,todietaryregimenssuchasvegetarianismandto
specificmedicalconditionssuchasType2diabetes.Giventhepersonalnatureofdieting,DietWeb
assurescustomersofcompleteprivacyoftheinformationtheyprovide.TothispointDietWebs
managementisproudofitssuccessinassuringtheprivacyofinformationsuppliedbyitscustomers
thisisaconstantbattlegiventhevarietyofintrusionattemptsbyvariousInternethackers.
DietWebnutritionplansarepaidinadvancebycustomersandofferedinincrementsofthirteen
weekswiththecustomershavingtheabilitytocancelandreceivearefundoftheunusedportionofthe
subscriptionthis results in a significant level of deferred revenue each period. Although some
DietWebmembersarebilledthroughuseofthepostalsystem,mostDietWebmemberscurrentlypurchase
programsandproductsusingcreditcards,withrenewalsbilledautomatically,untilcancellation.
OneweekofabasicDietWebmembershipcostslessthanonehalfthecostofaweeklyvisittothe
leadingclassroombaseddietprogram.Thepresident,Mr.WilliamReadings,suggeststhatinaddition
toitssuperiorcosteffectiveness,theDietWebonlinedietprogramissuccessfulrelativetoclassroom
basedprogramsduetoitscustomization,easeofuse,expertsupport,privacy,constantavailability,and
breadthofchoice.ThebasicDietWebmembershipincludes
Customized meal plans and workout schedules and related tools such as shopping lists,
journals,andweightandexercisetracking.
Interactiveonlinesupportandeducationincludingapproximately100messageboardson
varioustopicsofinteresttomembersandalibraryofdozensofmultimediaeducational
segmentspresentedbyexpertsincludingpsychologists,mentalhealthcounselors,
dietitians,fitnesstrainers,aspiritualadvisorandaphysician.
24/7/365 telephone support from a staff of approximately 30 customer service
representatives,nutritionistsandfitnesspersonnel.
Throughoutitsnineyearhistory,Mr.WilliamReadingshasservedaschiefexecutiveofficer.The
otherthreefoundersofthecompanyarealsoofficers.Afifthindividual,WillingsleyWilliamson,also
afounder,servedasChiefFinancialOfficeruntilmid20X8whenheleftthecompanyduetoa
differenceofopinionwithMr.Readings.ThefourfounderspurchasedMr.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
Williamsonsstockandinvestedanadditionalapproximately$1.2millionincommonstockduring
20X8soastolimittheuseoflongtermdebt.
Thecompanysboardofdirectorsiscurrentlycomposedofthefourindividualswhoremain
activeinthecompany;thesefourindividualsalsoserveasthecompanysauditcommittee;Mr.
Readingschairsboththeboardandtheauditcommittee.Previously,Mr.Readingshadalsoserved
37
ontheboardandtheauditcommittee.WithMr.Williamsonsdeparture,Ms.JaneJennings,
anotherofthefounders,becamethecompanysCFO.
Thenutritionanddietindustryinmanywaysthrivesbecauseindividualsarebecomingmore
awareofthenegativehealthandfinancialconsequencesofbeingoverweight,andconsiderimportant
bothweightlossandhealthyweightmaintenance.Astudybytworespectedresearchersconcluded
thatobesitywaslinkedtohigherratesofchronicillnessthanlivinginpoverty,thansmoking,orthan
drinking.Inaddition,theAmericanCancerSocietyreportedthatasmanyas14%ofcancerdeathsin
menand20%ofcancerdeathsinwomencouldberelatedtobeingoverweight.
Thefinancialcostsofexcessweightarealsohigh.A20X8studybasedondatafromamajor
automobilemanufacturershealthcareplanshowedthatanoverweightadulthasannualhealthcare
coststhatare7.3%higherthanapersoninahealthyweightrange,whileobeseindividualshave
annualhealthcarecoststhatare69%higherthanapersonofahealthyweight.Withhealthcarecost
inflationrunninginthedoubledigitsintheUnitedStatessince20X4,supportersoftheindustry
believethattheimplementationofeffectiveweightmanagementtoolswillattractmoreattentionfrom
insurers,employers,consumers,andthegovernment.AsofJanuary20X9fivenutritionorfitness
relatedbillswerebeingconsideredinCongress,andseveralstateshadenactedorwereconsidering
enactinglegislationrelatingtothesaleofjunkfoodinpublicschools.Inaddition,theUSFoodand
DrugAdministration,DepartmentofHealthandHumanServices,andFederalTradeCommissionare
contemplatingnewlabelingrequirementsforpackagedfoodandrestaurantfood,neweducationaland
motivationalprogramsrelatedtohealthyeatingandexercise,andincreasedregulationofadvertising
claimsforfood.
Inresponsetoconsumersgrowingdemandformorehealthfuleatingoptions,quickservice
andfullservicerestaurantshaveintroducednewofferingsincludingsalads,sandwiches,burgers,
andotherfooditemsdesignedfortheweightconsciousperson.Attheretaillevel,salesofnatural
andorganicfoodshavebeengrowingmorerapidlythantheoverallfoodandoverthecounterdrug
marketforthelastseveralyears.NutritionalsupplementsalesintheUS,forinstance,areestimated
tohavegrown34%between20X4and20X8,whilenaturalandorganicfoodsareestimatedtobe
growingatarateofapproximately15%annually.Also,theindustryhasatendencytochange
quicklyasdietingfadsregularlyareintroduced;someremainpopularforyears,someforonly
months.
Approximately60%oftheUSadultpopulation,or120millionadults,areoverweightand,of
those,theCalorieControlCouncilestimatesonlyabout50millionaredietinginagivenyear.
About15%ofthesedietersareusingacommercialweightlosscenter,generatingrevenuesof
approximately$1.5billionannually.DietWebtargetsdieterswhoareonline,whichrepresents
abouttwothirdsofthetotaluniverseatcurrentInternetpenetrationrates,or34millionadults,about
5millionofwhomarespendingapproximately$1billionatweightlosscenters.
Atthesametime,theonlinedietingsegmentofthemarketisgrowingrapidly.Theonlinediet
industryintheUSgeneratedinexcessof$100millionin20X8,comparedtorevenuesof
approximately$75millionin20X2.Theindustryincludesotheronlinenutritionanddietoriented
Websites.
AnothergroupofcompetitorstoDietWebarecommercialweightlosscenters,anindustrythat
hasshownmarkeddeclineinthelastdecade.AccordingtoMarketAnalysisEnterprises,thenumber
ofcommercialweightlosscentersintheUSdeclinedapproximately50%between20X2and20X8,
fromover8,600toapproximately4,400.DietWebcompetesagainstthissegmentonthebasisof
lowerprice,superiorvalue,convenience,availability,theabilitytopersonalizeamealplanonan
ongoingbasis,itsextensivesupportcapabilities,andthebreadthofitsmealplanoptions.
R
1.
A.
B.
C.
D.
2.
A.
B.
C.
D.
O
f
M
a
M
Ia
In
n
W
I
In
n
E
nM
i
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
38
3.
WhichofthefollowingismostaccurateconcerningDietWebs
auditcommittee?
(A)(B)(C)
(D)
A. Itshouldbeconsideredveryindependentinthatthecompanysfoundersserveonit.
B. Mr.Readingschairmanshipoftheauditcommitteecreatesasituationinwhichtheaudit
committeeservesastrongindependentroleduetohisclosenesstocompanyoperations.
C. Because all committee members are members of management, the audit committee lacks
independence.
D. Theauditcommitteedoesnothaveenoughmembersinthatthesizeoftheboardofdirectors
shouldbelessthanthatoftheauditcommittee.
(A) (
B
)
(
C
)
(
D
)
4.
ResignationofMr.Williamson.
Dominationofmanagementbycompanyfounders.
Issuanceofdebtduring20X8.
CompetitionwithnonInternetweightlossorganizations.
(A)(B)(C)
(D)
5.WhichofthefollowingisthemostsignificantriskfacingDietWebthatmightcauseittonotbe
abletocontinueincreasingsales?
A.
B.
C.
D.
AdecreasingmarketintheUnitedStatesfordietaryproducts.
DietWebmustrespondtodietingfadsonatimelybasis.
TheconstantlydecreasingnumberofindividualsintheUnitedStates.
ObsolescenceoftheInternet.
TaskBasedSimulation5
FinancialStatement
Analysis
Authoritative
Literature
Help
DietWebInc.(hereafterDietWeb)wasincorporatedandbeganbusinessinMarchof20X1,seven
yearsago.Youareworkingonthe20X8audityourCPAfirmsfifthauditofDietWeb.Analyzethe
followingfinancialstatementsandreplytoeachofthequestionsthatfollow.
DietWeb,Inc.
BALANCESHEET
December31,20X8and20X7
(inthousands)
20X8
20X7
$3,032
485
59
175
3,751
$1,072
450
609
230
2,361
3,321
3,926
Totalassets
$7,072
$6,287
Liabilitiesandshareholdersequity
Currentliabilities
Accountspayable
Currentmaturitiesofnotespayable
Deferredrevenue
Othercurrentliabilities
Totalcurrentliabilities
$1,070
42
1,973
171
3,256
$909
316
1,396
12
2,633
Assets
Currentassets
Cashandcashequivalents
Tradereceivables
Prepaidadvertisingexpenses
Prepaidexpensesandothercurrentassets
Totalcurrentassets
Fixedassets,net
Longtermdebt,lesscurrentmaturity
Accruedliabilities
Deferredtaxliability
Totalliabilities
Shareholdersequity
Commonstock
Retainedearnings
Totalshareholdersequity
34
792
15
4,097
176
690
145
3,644
6,040
(3,065)
2,975
4,854
(2,211)
2,643
Totalliabilitiesplusshareholdersequity
$7,072
$6,287
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
Revenue
DietWeb,Inc.
INCOMESTATEMENT
TwoYearsEndedDecember31,20X8and20X7
(inthousands)
20X8
$19,166
20X7
$14,814
39
Costsandexpenses
Costofrevenue
Productdevelopment
Salesandmarketing
Generalandadministrative
Depreciationandamortization
Impairmentofintangibleassets
Totalcostsandexpenses
2,326
725
13,903
2,531
629
35
20,149
1,528
653
8,710
2,575
661
14,127
(983)
687
Netincomebeforetaxes
Incometaxbenefit
Netincome(loss)
129
125
$(854)
$812
DietWeb,Inc.
STATEMENTOFCASHFLOWS
YearEndedDecember31,20X8
20X8
Cashflowsfromoperations
Netincome(loss)
Adjustmentstonetincome
Depreciation
Increaseinreceivables
Decrease(Increase)inprepaidadvertising
Decreaseinothercurrentassets
Increase(Decrease)inaccountspayable
Increaseinaccruedliabilities
Increase(Decrease)indeferredrevenue
Increaseincommonstockissued
Increaseinothercurrentliabilities
Netcashprovided(used)byoperations
20X7
$(854)
812
629
(35)
550
55
161
102
432
1,186
159
2,385
660
(47)
(650)
74
(540)
43
(665)
43
(270)
Cashflowsfrominvestingactivities
Purchaseofpropertyandequipment
(320)
2,016
Cashflowsfromfinancingactivities
Newdebt
Debtpayments
Netcashprovided(used)byfinancingactivities
613
(718)
(105)
40
(918)
(878)
Netincreaseincashandcashequivalents
$1,960
Cashandequivalentsatbeginningofyear
$1,072
868
204
Cashandequivalentsatendofyear
$3,032
1,072
Required
(A) (B) (C) (D)
1.Themostlikelymisstatementinthefinancialstatementsis
A.
B.
C.
Theincreaseincashin20X8.
Treatmentofimpairedintangibleassetsasanexpensein20X8.
Treatmentofcommonstockissuedasanadjustmenttonetincome(loss)undercashflow
fromoperations.
D.
Anincometaxbenefitontheincomestatementascontrastedtoincometaxexpense.
(A) (B
)
(C
)
(D
)
2.Whichofthefollowingisthemostunexpectedchangeonthebalancesheet,ifoneassumesthe
revenueincreasein20X8iscorrect?
A. Decreaseinprepaidadvertisingexpenses.
B. Increaseinaccountspayable.
C. Decreaseindeferredrevenues.
D. Increaseincommonstock.
4
0
C. I
D. nM
r
4. W
A.
B.
C.
D.
5.
A.
B.
C.
D.
C
l
C
lA
R
e
W
T
h
T
hA
n
A
n
TaskBasedSimulation6
RiskofMaterial
MisstatementAnalysis
Authoritative
Literature
Help
YouareworkingwithWilliamBond,CPA,andyouareconsideringtheriskofmaterial
misstatementinplanningtheauditofToxicWasteDisposal(TWD)Companysfinancialstatements
fortheyearendedDecember31,20X0.TWDisaprivatelyownedentitythatcontractswithmunicipal
governmentstoremoveenvironmentalwaste.Basedonlyontheinformationbelow,indicatewhether
eachofthefollowingfactorswouldmostlikelyincrease(I),decrease(D),orhavenoeffectontherisk
ofmaterialmisstatement(N).
3. The
internal
1. Becausemunicipalitieshavereceivedincreasedfederalandstatefunding
auditor
for environmental purposes, TWD returned to profitability for the first
reports
yearfollowingthreeyearswithlosses.
to the
controll
2. TWDsBoardofDirectorsiscontrolledbyMead,themajoritystockholder,
er and
whoalsoactsasthechiefexecutiveofficer.
the
controllerreportstoMead.
4.
5.
TWDsbankhasaloanofficerwhomeetsregularlywithTWDsCEOand
controllertomonitorTWDsfinancialperformance.
6.
TWDsemployeesarepaidbiweekly.
7.
TWDhassuchastrongfinancialpresenceinitshistorysoastoallow
it often to dictate the terms or conditions of transactions with its
suppliers.
8.
During20X1,TWDchangeditsmethodofpreparingitsfinancialstatements
fromthecashbasistogenerallyacceptedaccountingprinciples.
9.
suresthatTWDincludedinprioryearsfinancialstatementsarebeing
removedfromthe20X1financialstatements.
11. DuringDecember20X1,TWDsignedacontracttoleasedisposal
equipmentfromanentityownedbyMeadsparents.Thisrelatedparty
transactionisnotdisclosedinTWDsnotestothe20X1financial
statements.
(I)
(D)
(N)
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
41
(I)
(D)
(N)
12. DuringDecember20X1,TWDcompletedabartertransactionwitha
municipality.TWDremovedwastefromthemunicipallyownedsite
andacquiredtitletoanothercontaminatedsiteatbelowmarketprice.
TWDintendstoservicethisnewsitein20X2.
13. DuringDecember20X1,TWDincreaseditscasualtyinsurancecoverageonseveralpiecesof
sophisticatedmachineryfromhistoricalcosttoreplacementcost.
14. InquiriesaboutthesubstantialincreaseinrevenueTWDrecordedinthefourthquarterof20X1
disclosedanewpolicy.TWDguaranteedtoseveralmunicipalitiesthatitwouldrefundthe
federalandstatefundingpaidtoTWDifanymunicipalityfailsafederalorstatesitecleanup
inspectionin20X2.
15. AninitialpublicofferingofTWDsstockisplannedforlate20X2.
TaskBasedSimulation7
Identifying
Risks
Authoritative
Literature
Help
Planning
Youarebeginningthe20X8auditofToastco,anonpubliccompanythatmanufacturesvarious
kitchenproducts.ThisisyourfirmssixthannualauditofToastco.
Toastcosmostprofitableproductisadeluxetoasterthatisdesignedforthosewhowantatruly
outstandingtoaster.ThetoasterwasfirstmarketedthroughSkyMallMagazine,whichoffers
specialtytypeproductstoairplanepassengers.Demandhasgrownsothatatthispointthecompany
advertisestheproductmuchmorebroadlythroughavarietyofmedia.Saleshavebeenoutstanding
fromthestartandcontinuetoincrease.Therecordedlevelofsalesfor20X8indicatesthatthe
companynowcontrolsapproximately5%ofthetoastermarket,whichrepresents55%ofcompany
sales.Inadditiontothetoaster,thecompanymanufacturesotherproducts,includingtoasterovens,
coffeemakers,foodblenders,andelectriccanopeners.Mostofthemanufacturingprocessis
performedinseveralplantsinAsia.
ThehighlysuccessfultoasteristheproductofBillWilliams,whobecameToastcoschief
executiveofficerin20X3.Billandseveralotherofficersinvestedheavilyinthecompanyatthattime
withtheintentofultimatelysellingcommonstocktothepublic.Hisandthoseindividualslivesare
centeredaboutthefirmandmakingitasuccess.Consistently,Toastcoisofcriticalimportanceto
eachoftheseindividualsfinancially.
RecentlyyoudiscussedthecomingauditwithBill.Youquicklyfoundthathewaselatedthatthe
companyhadearned$1.21pershare,onecentmorethanhehadassuredthebankthathadprovided
Toastcowithextensivefinancingduring20X8.HesuggestedthatsomehadfearedthatToastco
wouldntmakeitaftersomewhatweaksecondandthirdquarters,butthatheknewallalongthata
strongfourthquarterwasaheadandthatitwouldbringusthrough.Healsopointedoutthatsalesare
upabout38%comparedtothepreviousyearandincomeby54%.Furthermore,heindicatedthatan
initialpublicofferingofsecuritieswasplannedforapproximatelyeighteenmonthsfromnow.
Toastcosoutstandingperformanceforthepastseveralyearsisinlargepartduetothehighly
profitabletoaster,withotherproductsgainingsalesatapproximatelytheindustrysgrowthrate.In
fact,Billindicatedthatthetoasterhasbecomeevenmoreprofitablethisyearduetoreengineeringof
itsproductionprocessandcomponents,whichbroughtcostsofproductiondownanddecreasedsales
returnsandallowances.
Billalsosuggestedtoyouthatthe$42,216,000bankloanreceivedduringtheyearhasbeen
primarilyusedtoincreaseinventoriesandfixedassetstosupporttherapidlyrisingdemandforthe
toaster,aswellasToastcosotherproducts.Hepointedoutthatthecompanycouldneverhave
achieveditsprojectedearningspersharegoalwithoutthebankssupport.Thisbanksupporthasalso
allowedToastcotoworkondevelopingwhatBillreferstoasournextsuperproductan
improvedcanopenerthatworkswellwithallsizesofcansanddoesntleaveamess.
Finally,Billsaidthattherewassomesadnews.TheChairmanoftheBoardofDirectors,John
Whing,anindependentdirector,hadbeenforcedtostepdownforhealthreasons.Billhadreplaced
Mr.WhingasChairmanoftheBoard,andToastcoVicePresidentSamAdamsonfilledtheemptyseat
ontheboardofdirectors.ThesevenmemberboardisnowcomposedofBill(whowillbeginserving
asChairman),SamAdamson,twoothersfrommanagement,andthethreeindependentdirectors.The
auditcommitteehasnotbeenaffectedbythechange,asthethreeindependentdirectorscontinueto
serveinthatrole.
IndustryInformation
IntheportionsofthekitchenproductindustryinwhichToastcooperates,demandisinfluenced
byeconomictrendssuchasincreasesordecreasesinconsumerdisposableincome,availabilityof
credit,andhousingconstruction.Competitionisveryactiveinallproductsandcomesfromanumber
ofprincipalmanufacturersandsuppliers.Animportantfactoristhedegreeofproductdifferentiation
achievedthroughinnovationandnewproductfeatures.Othersignificantfactorsincludeproduct
qualityandcost,brandrecognition,customerresponsiveness,andapplianceservicecapability.
Overall,fortheindustry,saleshavebeenandareexpectedtoremainrelativelystablewithaslight
increaseincreaseshaveapproximated3%industrywideperyearduringthepastfiveyears,andare
expectedtocontinueatthatrateofincreaseforthe
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
42
nextfiveyears.MuchofthemanufacturingoftheseproductstakesplaceinAsia,andtoalesserextentinSouthAmerica.In
creasingly,Asiancompaniesarebecomingdirectlyinvolvedinmarketingtheirownhouseholdproducts.
Required
(A)(B)(C)(D)
1.
Whichofthefollowingidentifiesanaspectofthecompanysbusinessmodel,strategies,and/or
businessenvironmentthatismostlikelytoincreaseToastcosinherentrisk?
A.
B.
C.
D.
ManufacturinginAsia.
Anexpectedindustrygrowthrateinsalesofapproximately3%.
Productobsolescenceorlossofproductdifferentiationadvantages.
Overstatedaccountsreceivableduetointernalcontroldeficiencies.
(A)(B)(C)(D)
2.Whichofthefollowingidentifiesasituationmostlikelytoincreasetheriskofmisstatementarising
fromfraudulentfinancialreporting?
A.
B.
C.
D.
3.
Thehouseholdproductsindustryseemsstable,andisnotrapidlygrowing.
Toastcoreportedastrongfourthquarterthatbroughtituptoexpectationsforearningspershare.
Toastcocontrolsapproximately5%ofthemarketfortoasters.
Toastcohasonerelativelyprofitableproduct,andanumberofproductsthatarenotasprofitable.
(A)(B)(C)(D)
Whichofthefollowingidentifiesanaspectofthecompanysbusinessmodel,strategies,and/or
businessenvironmentthatismostlikelytoincreasetheriskofmisstatementarisingfromfraudulent
financialreporting?
A.
B.
C.
D.
Toastcosellsmorethanonetypeofproduct.
ThepresidentswealthisbasedonthesuccessofToastco.
Theauditcommitteeiscomposedentirelyofindependentdirectors.
Toastcocontinuestohireyourfirmforitsfifthyear.
RatioAnalysis
BelowaretwosetsofratiosthatwereidentifiedassignificantinthecurrentandprioryearsauditsofToastco.Foreach
pair,comparethevaluesofeachratio.Thenselectanauditfindingthatisconsistentwiththesemetrics.Eachoftheaudit
findingsmaybeusedonce,morethanonce,ornotatall.Ratiosusingbalancesheetnumbersarebasedonendofyear
balances.
Ratio
Grossmarginpercentage
Currentratio
A.
B.
C.
D.
E.
F.
G.
20X8
0.154
2.619
20X7
0.166
3.688
Substantiveprocedure
Increasesincostsofpurchaseswerenotcompletelypassedontocustomersthroughhighersellingprices.
Increasesintradereceivables.
Ownersequityincreasedduetoretentionofprofits.
Alargerpercentageofsalesoccurredduringthelastmonthof20X8,ascomparedto20X7.
Interestexpensedecreasedduring20X8.
Thepercentagetaxincludedintheprovisionforincometaxesfor20X8waslessthanthepercentagein20X7.
Asignificantamountoflongtermdebtbecamecurrent.
(A)(B)(C)(D)(E)
(F)(G)
1. Anauditfindingmostconsistentwiththechangeinthegrossmarginpercentage
2. Anauditfindingmostconsistentwiththechangeinthecurrentratio
Ratio
Inventoryturnover
Returnonequity
H.
I.
J.
K.
L.
M.
20X8
10.52
0.40
20X7
7.95
0.67
Auditfindings
Increasesincostsofpurchaseswerenotcompletelypassedontocustomersthroughhighersellingprices.
Increasesintradereceivables.
Ownersequityincreasedduetoretentionofprofits.
Alargerpercentageofsalesoccurredduringthelastmonthof20X8,ascomparedto20X7.
Interestexpensedecreasedduring20X8.
Thepercentagetaxincludedintheprovisionforincometaxesfor20X8waslessthanthepercentagein20X7.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
(K)(L)(M)
43
ObservedRatio
Changes
Authoritative
Literature
Help
Items1through6representanauditorsobservedchangesincertainfinancialstatementratiosoramountsfromthe
prioryearsratiosoramounts.Foreachobservedchange,selectthemostlikelyexplanationorexplanationsfromListB.
Selectonlythenumberofexplanationsasindicated.Answersonthelistmaybeselectedonce,morethanonce,ornotatall.
ListB
Itemsshippedonconsignmentduringthelastmonthoftheyearwererecordedassales.
Asignificantnumberofcreditmemosforreturnedmerchandisethatwereissuedduringthelastmonthoftheyear
werenotrecorded.
C. Yearendpurchasesofinventorywereoverstatedbyincorrectlyincludingitemsreceivedinthefirstmonthof
thesubsequentyear.
D.
Yearendpurchasesofinventorywereunderstatedbyincorrectlyexcludingitemsreceivedbeforetheyearend.
E.
Alargerpercentageofsalesoccurredduringthelastmonthoftheyear,ascomparedtotheprioryear.
F.
Asmallerpercentageofsalesoccurredduringthelastmonthoftheyear,ascomparedtotheprioryear.
G.
Thesamepercentageofsalesoccurredduringthelastmonthoftheyear,ascomparedtotheprioryear.
H.
Salesincreasedatthesamepercentageascostofgoodssold,ascomparedtotheprioryear.
I.
Salesincreasedatagreaterpercentagethancostofgoodssoldincreased,ascomparedtotheprioryear.
J.
Salesincreasedatalowerpercentagethancostofgoodssoldincreased,ascomparedtotheprioryear.
K.
Interestexpensedecreased,ascomparedtotheprioryear.
L.
Theeffectiveincometaxrateincreased,ascomparedtotheprioryear.
M.
Theeffectiveincometaxratedecreased,ascomparedtotheprioryear.
N.
Shorttermborrowingwasrefinancedonalongtermbasisatthesameinterestrate.
O.
Shorttermborrowingwasrefinancedonalongtermbasisatlowerinterestrates.
P.
Shorttermborrowingwasrefinancedonalongtermbasisathigherinterestrates.
A.
B.
Auditorsobservedchanges
1. Inventoryturnoverincreasedsubstantiallyfrom
theprioryear.(Select3explanations)
2. Accountsreceivableturnoverdecreasedsubstan
tiallyfromtheprioryear.(Select3explanations)
3. Allowancefordoubtfulaccountsincreasedfrom
theprioryear,butallowancefordoubtfulaccounts
asapercentageofaccountsreceivabledecreased
fromtheprioryear.(Select3explanations)
4. Longtermdebtincreasedfromtheprioryear,but
interestexpenseincreasedalargerthan
proportionateamountthanlongtermdebt.(Select
oneexplanation)
5. Operatingincomeincreasedfromtheprioryear
althoughtheentitywaslessprofitablethaninthe
prioryear.(Selecttwoexplanations)
6. Grossmarginpercentagewasunchangedfromthe
prioryearalthoughgrossmarginincreasedfrom
theprioryear.(Selectoneexplanation)
(A)(B)(C)(D)(E)(F)(G)(H)(I)(J)(K)(L)(M)(N)(O)(P)
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
44
TaskBasedSimulation9
Assertionsand
AuditProcedures
Authoritative
Literature
Help
YouareastaffauditorwithWilliamsandCo.CPAs.BillJones,anewhire,hascometoyouwith
questionsconcerningassertionsandauditprocedures.For1.through6.matcheachassertionwith
thestatementthatmostcloselyapproximatesitsmeaning.Eachstatementmaybeusedonlyonce.
A.
B.
C.
D.
E.
F.
Statement
Thereissuchanasset
Thecompanylegallyownstheassets
Allassetshavebeenrecorded
Transactionsarerecordedinthecorrectaccountingperiod
Assetsarerecordedatproperamounts
Assetsareproperlyclassified
(A)(B)(C)(D)(E)(F)
Assertion
1. Completeness
2. Cutoff
3. Existenceandoccurrence
4. Presentationanddisclosure
5. Rightsandobligations
6. Valuation
Auditorsperformauditprocedurestoobtainauditevidencethatwillallowthemtodraw
reasonableconclusionsastowhethertheclientsfinancialstatementsfollowgenerallyaccepted
accountingprinciples.Matcheachauditprocedurewithitstype.Eachtypeofauditprocedureisused,
oneofthemtwice.
A.
B.
C.
D.
Typeofauditprocedure
Analyticalprocedures
Testsofcontrols
Riskassessmentprocedures(otherthananalyticalprocedures)
Testofdetailsofaccountbalances,transactions,ordisclosures
Auditprocedures
1. Prepareaflowchartofinternalcontroloversales.
2. Calculatetheratioofbaddebtexpensetocreditsales.
3. Determinewhetherdisbursementsareproperlyapproved.
4. Confirmaccountsreceivable.
5. Comparecurrentfinancialinformationwithcomparablepriorperiods.
TaskBasedSimulation10
AuditRiskand
ItsComponentsAuthoritative
Literature
Help
YourecentlygraduatedfromcollegeandjoinedaCPAfirmasajuniorassistant.Youhavebeen
assignedtoauditWiglo,Inc.AtlunchoneofWiglosaccountantssaidtoyouthatheishavingsome
troublewithbasicauditconcepts,andthisbothershimsincehethinkshemaywanttotaketheCPA
examatsomepointinthefuture.Hehasthefollowingquestionsforyoutowhichyoushouldreply
withayesifitiscorrect,andanoifitisincorrect.
Yes
No
1.
AmIrightthattheriskofmaterialmisstatementiscomposedofthethreecomponentsof
auditrisk?
2.
3.
4.
5.
6.
A
m
D
o
D
7.
8.
Isinherentriskthepossibilityofmaterialmisstatementbeforeconsideringtheclients
internalcontrol?
InourcompanyIthinkourcontrolriskislowerthisyearthanitwaslastyear;doesthatmeanthat
thereisanincreaseintheriskofmaterialmisstatement?
Research:
Supervision
Authoritative
Literature
Help
YougraduatedfromcollegerecentlyandjoinedaCPAfirmasanassistant.Youhavebeen
assignedtotheauditofPJWholesale,Inc.TheCEOofthenonpubliccompanycannotunderstandwhy
asupervisorfromyourfirmneedstoreviewyourauditwork,giventhatyouhaveaformalaccounting
educationandtookauditingcoursesincollege.
Titlechoices
A. AU
B.
PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
1.
WhichtitleoftheProfessionalStandardsaddressesthisissueand
willbehelpfulinrespondingtotheCEO?
2.
Entertheexactsectionandparagraphwithhelpfulinformation.
(A)(B)(C)(D)(E)(F)(G)
(H)
TaskBasedSimulation12
Research:Tone
attheTop
Authoritative
Literature
Help
BillJensen,CPA,hasjustbecomepartnerofWigg&Co.CPAs.Heisconcernedthatthetoneat
thetopofthefirmcouldusesomeimprovementinthemessagesitsendstoemployeesconcerningthe
firmsculture.HehasaskedyoutofindanyprofessionalstandardsthataddresstheneedforaCPA
firmtohaveapropertoneatthetop.
Titlechoices
A. AU
B.
PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
1.
WhichtitleoftheProfessionalStandardsaddressesthisissueand
willbehelpfulinrespondingtothepartner?
2.
Entertheexactsectionandparagraphswithhelpfulinformation.
(A)(B)(C)(D)(E)(F)(G)
(H)
46
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
TaskBasedSimulation13
EffectsonAuditRiskComponents
Authoritative
Literature
Help
BestwoodFurniture,Inc.,aprivatecompanythatproduceswoodfurniture,isundergoingayear2
audit.ThesituationsinthetablebelowdescribechangesBestwoodmadeduringyear2thatmayor
maynotcontributetoauditrisk.Foreachsituation,selectfromthelistprovidedtheimpact,ifany,that
thesituationhasonaspecificcomponentofauditriskfortheyear2audit.Aselectionmaybeused
once,morethanonce,ornotatall.
I
m
A
.B
.C
.D
.E
.F
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.
S
i
1.
D
u
2.
I
n
E
a
3.
TaskBasedSimulation14
Research
Authoritative
Literature
Help
QualityControlStandards
AssumethatyouareemployedbyWilson&WilsonCPAs.Oneofthepartnershasaskedyouto
researchtheprofessionalstandardsforthereferencethatidentifiestherequirementsfordocumentation
ofafirmsqualitycontrolpoliciesandprocedures.
Titlechoices
A. AU
B.
PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
1.
WhichtitleoftheProfessionalStandardsaddressesthisissueand
willbehelpfulinrespondingtothepartner?
2.
Entertheexactsectionandparagraphswithhelpfulinformation.
(A)(B)(C)(D)(E)(F)(G)
(H)
MODULE2 ENGAGEMENTPLANNINGANDASSESSINGRISKS
47
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
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20.
a
d
c
d
a
a
d
b
b
a
c
c
b
b
b
b
d
a
c
b
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27.
28.
29.
30.
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
b
b
c
a
b
a
b
a
d
b
d
c
a
a
c
d
d
b
d
c
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41.
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48.
49.
50.
51.
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53.
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55.
56.
57.
58.
59.
60.
c
d
a
a
a
a
b
d
b
a
a
a
c
b
d
d
d
c
b
a
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61.
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79.
80.
c
b
a
b
b
c
b
d
a
b
b
a
c
d
c
a
c
b
c
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81.
82.
83.
84.
85.
86.
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89.
90.
91.
92.
93.
94.
95.
96.
97.
98.
99.
100.
b
c
a
d
d
a
d
b
a
d
c
a
d
c
b
c
a
c
b
b
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__ 102. b
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__ 103. b
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__ 104. d
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__ 105. b
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__ 106. d
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__ 107. a
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__ 108. d
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__ 109. c
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__ 110. d
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__ 111. a
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__ 112. b
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__ 1st:__/113=__%
__ 2nd:__/113=__%
MULTIPLECHOICEANSWEREXPLANATIONS
A. Overview
1.
(a)Therequirementistoidentifya
conceptualdifferencebetweenthe
attestationstandardsandgenerally
acceptedauditingstandards.Answer
(a)iscorrectbecauseAT101states
thattheattestationstandardsdonot
applytoauditsofhistoricalfinancial
statements.Answer(b)isincorrect
becauseanindependentmental
attitudeisrequiredforattestation
engagements.Answer(c)isincorrect 4.
becauseanattestengagementmaybe
relatedtoabusinessacquisition
studyorafeasibilitystudy.Answer
(d)isincorrectbecausewhilethereis
nointernalcontrolfieldworkstandard
undertheattestationstandards,botha
planningandanevidencestandardof
fieldworkareincluded.
2.
(d)Therequirementistoidentifythe
replywhichisnotanattestation
standard.Answer(d)iscorrect
becausetheattestationstandardsdo
notincludearequirementthata
sufficientunderstandingofinternal
controlbeobtainedtoplanthe
engagement.Thereisnointernal
controlstandardbecausetheconcept
ofinternalcontrolmaynotbe
relevanttocertainassertionson
whichaCPAmaybeengagedto
report(e.g.,aspectsofinformation
aboutcomputersoftware).Answers
(a),(b),and(c)areallincorrect
becausestandardsexistforevidence,
reportingontheassertionorsubject
matter,andproperplanning.
3.
(c)Therequirementistoidentifythe
characteristicthatismostlikelytobe
uniquetotheauditworkofCPAsas
comparedtoworkperformedby
practitionersofotherprofessions.
Answer(c)iscorrectbecause
independenceisabsolutelyrequired
fortheperformanceofaudits;other
professionsdonotingeneralrequire
suchindependence.Answers(a),(b),
and(d)areincorrectbecausethe
variousprofessionsrequiredue
professionalcareandcompetence
andhaveacomplexbodyof
knowledge.
(d)Therequirementistodeterminewhatis
meantbythethirdgeneralstandards
requirementofduecareintheperformanceof
anaudit.Answer(d)iscorrectbecauseduecare
requirescriticalreviewateverylevelof
supervisionoftheworkdoneandthejudgment
exercisedbythoseassisting
intheaudit.Answer(a)isincorrectbecausethe
duecarestandarddoesnotdirectlyaddress
safeguardsoveraccesstoassetsandrecords.
Answer(b)isincorrectbecauseduecaredoes
notrelatetoalimitedreviewofemployeefraud
andillegalacts.Answer(c)isincorrectbecause
thefirstgeneralstandardaddressestechnical
trainingandproficiencyasanauditor.
5.(a)Therequirementistoidentifythefocus
ofafinalwrapupreviewperformedbyasecond
partnerwhohasnotbeeninvolvedintheaudit.
Answer(a)iscorrectbecausethissecondor
coldreviewaimsatdeterminingwhetherthe
financialstatementsresultinfairpresentationin
conformitywithGAAPandwithwhether
sufficientappropriateevidencehasbeen
obtained.Answer(b)isincorrectbecausemost
frequentlyfraudinvolvingtheclientsman
agementanditsemployeeshavenotbeen
discoveredand,eveniftheyhavebeen,the
focusofthereviewisstillonthefairnessof
presentationofthefinancialstatements.An
swers(c)and(d)areincorrectbecause
decisionsonmaterialityandcommunications
withtheauditcommitteeareonlytwoofthe
manymattersthereviewmayaddressinan
efforttoaddressfairnessofpresentationofthe
financialstatements.
A.1.
6.
FinancialStatementAssertions
(a)Therequirementistoidentifythecategories
offinancialstatementassertions.Answer(a)is
correctbecausetheprofessionalstandards
establishfinancialstatementassertionsfor
accountbalances,classesoftransactionsand
disclosures.Answer(b)isincorrectbecause
financialstatementassertionsareestablished
fordisclosures.Answer(c)isincorrect
becausefinancialstatementassertionsare
establishedforclassesoftransactions.Answer
(d)isincorrectbecausefinancialstatement
assertionsareestablishedforbothclassesof
transactionsanddisclosures.
7.
(d)Therequirementistoidentifythe
item thatis not a financialstatement
assertionrelatingtoaccountbalances.
Answer (d) is correct because
valuationandallocationisanaccount
balance assertion, not valuation and
com
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
48
petence.Answer(a)isincorrectbecause
completenessisanassertionrelatingtoaccount
balances.Answer(b)isincorrectbecause
existenceisanassertionrelatingtoaccount
balances.Answer(c)isincorrectbecauserights
andobligationsisanassertionrelatingto
accountbalances.
A.2.
AuditRisk
8.
(b)Therequirementistodeterminea
likelyauditorreactiontoadecreased
acceptablelevelofdetectionrisk.
Answer(b)iscorrectbecause
postponementofinterimsubstantive
teststoyearenddecreasesdetection
riskbyreducingtheriskforthe
periodsubsequenttothe
performanceofthosetests;other
approachestodecreasingdetection
riskincludechangingtomore
effectivesubstantivetestsand
increasingtheirextent.Answer(a)is
incorrectbecauseincreased,not
reduced,substantivetestingis
required.Answer(c)isincorrect
becauseinherentriskmustbe
consideredinplanning,eitherby
itselforincombinationwithcontrol
risk.Answer(d)isincorrectbecause
testsofcontrolsmustbeperformed
toreducetheassessedlevelofcon
trolrisk.
9.
(b)Therequirementistoidentifythe
riskthatanauditorwillconclude,
basedonsubstantivetests,thatama
terialerrordoesnotexistinanaccountbalance
when,infact,sucherrordoesexist.Answer(b)
iscorrectbecausedetectionriskistheriskthat
theauditorwillnotdetectamaterial
misstatementthatexistsinanassertion.
Detectionriskmaybeviewedintermsoftwo
components(1)theriskthatanalytical
proceduresandotherrelevantsubstantivetests
wouldfailtodetectmisstatementsequalto
tolerablemisstatement,and(2)theallowable
riskofincorrectacceptanceforthesubstantive
testsofdetails.Answer(a)isincorrect
becausesamplingriskarisesfromthe
possibilitythat,whenatestofcontrolsora
substantivetestisrestrictedtoasample,the
auditorsconclusionsmaybedifferentfromthe
conclusionsheorshewouldreachifthetests
wereappliedinthesamewaytoallitemsin
theaccountbalanceorclassoftransactions.
Whenrelatedtosubstantivetestssampling
riskisonlyapartoftheriskthattheauditors
substantivetestswillnotdetectamaterial
misstatement.An
swer(c)isincorrectbecausenonsamplingrisk
includesonlythoseaspects ofauditriskthat
are not due to sampling. Answer (d) is
incorrect because inherent risk is the
susceptibility of an assertion to a material
11. (c)Therequirementistodetermine
whetherinherentrisk,controlrisk,
anddetectionriskmaybeassessed
innonquantitativeterms.Answer(c)
iscorrectbecausealloftheserisks
maybeassessedineither
quantitativetermssuchas
percentages,ornonquantitative
termssuchasarangefroma
minimumtoamaximum.
12. (c)Therequirementistodetermineamanner
inwhichinherentriskandcontrolriskdiffer
fromdetectionrisk.Answer(c)iscorrect
becauseinherentriskandcontrolriskexist
independentlyoftheauditofthefinancial
statementsasfunctionsoftheclientandits
environment,whereasdetectionriskrelatesto
theauditorsproceduresandcanbechangedat
hisorherdiscretion.Answer(a)isincorrect
becauseinherentriskandcontrolriskare
functionsoftheclientanditsenvironmentand
donotarisefrommisapplicationofauditing
procedures.Answer(b)isincorrectbecause
inherentrisk,controlriskanddetectionrisk
mayeachbeassessedineitherquantitativeor
nonquantitativeterms.Answer(d)isincorrect
becauseinherentriskandcontrolriskare
functionsoftheclientanditsenvironment,
theycannotbechangedattheauditors
discretion.However,theassessedlevelsof
inherentandcontrolrisk(notaddressedinthis
question)maybeaffectedbyauditordecisions
relatingtothecostofgatheringevidenceto
substantiateassessedlevelsbelowthe
maximum.
13. (b)Therequirementistodetermine
thebestwayforanauditortoachieve
anoverallauditrisklevelwhenthe
auditevidencerelatingtocontrolrisk
indicatestheneedtoincreaseits
assessedlevel.Answer(b)iscorrect
becauseadecreaseindetectionrisk
willallowtheauditorachievean
overallauditrisklevelsubstantially
thesameasplanned.Answer(a)is
incorrectbecauseadecreasein
substantivetestingwillincrease,not
decrease,detectionriskandthereby
increaseauditrisk.Answer(c)is
incorrectbecauseanincreasein
inherentriskwillalsoincreaseaudit
risk.Answer(d)isincorrectbecause
thereappearstobenojustification
forincreasingmaterialitylevels
beyondthoseusedinplanningthe
audit.
14. (b)Therequirementistodetermine
therelationshipbetweencontrolrisk
anddetectionrisk.Inverseiscorrect
becauseascontrolriskincreases
(decreases)detectionriskmust
decrease(increase).
A.3.
Materiality
15. (b)Therequirementistoidentifythe
informationthatanauditorwould
mostlikelyuseindeterminingapre
liminaryjudgmentaboutmateriality.
Answer(b)iscorrectbecausemany
materialitymeasuresrelatetoan
annualfigure(e.g.,netincome,sales).
Answer(a)isincorrectbecausethe
preliminaryjudgmentabout
materialityisafactorusedin
determiningtheanticipatedsample
size,notthereverseassuggestedby
thereply.Answers(c)and(d)are
incorrectbecausematerialitywillnot
normallybeaffectedbytheresultsof
theinternalcontrolquestionnaireor
thecontentsofthemanagement
representationletters.
16. (b)Therequirementistoidentifythe
statementthatisnotcorrect
concerningmateriality.Answer(b)is
theproperreplybecausetheauditor
considersmaterialityforplanning
purposesintermsofthesmallest,not
thelargest,aggregateamountof
misstatementthatcouldbematerial
toanyoneofthefinancial
statements.Answers(a),(c),
and (d) all represent correct statements about
materiality.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
17. (d)Therequirementistoidentifythe
elementswhichunderliethe
applicationofgenerallyaccepted
auditingstandards,particularlythe
standardsoffieldworkandreporting.
Answer(d)iscorrectbecauseAU
150statesthatmaterialityand
relativeriskunderlietheapplication
ofallthestandards.Answer(a)is
incorrectbecauseaconsiderationof
internalcontrolisoneofthefield
standards,notanelementunderlying
thestandards.Answer(b)isincorrect
becausethesecondfieldwork
standard,onevidence,relatesmost
directlytocorroboratingevidence.
Answer(c)isincorrectbecause
whileitisaccuratethatquality
controlstandardsencompassthe
firmspoliciesandprocedurestopro
videreasonableassuranceof
conformingwithprofessional
standards,thestandardsarenot
relatedmoredirectlytothefieldwork
andreportingstandardsthantothe
generalgroupofgenerallyaccepted
auditingstandards.
18. (a)Therequirementistodetermine
theappropriatelevelofmaterialityfor
planningpurposeswhen$10,000
wouldhaveamaterialeffectonan
entitysincomestatement,but
$20,000wouldmateriallyaffectthe
balancesheet.AU312statesthatthe
auditshouldbedesignedtoobtain
reasonableassuranceaboutwhether
thefinancialstatementsarefreeof
materialmisstatement.Becauseitwill
ordinarilybedifficulttoanticipate
duringtheplanningstageofanaudit
whetherallmisstatementswillaffect
onlyonefinancialstatement,the
auditorisgenerallyrequiredtouse
thelowerfinancialstatementfigure
formostportionsofplanning.
Therefore,answer(a),$10,000,is
correct.Answers(b),(c),and(d)are
allincorrectbecausetheyaredollar
amountswhichexceedthelowest
levelofmateriality.
19. (c)Therequirementistoidentifythe
informationthatanauditorwouldbemost
likelytouseinmakingapreliminaryjudgment
aboutmateriality.Answer(c)iscorrectbecause
auditorsoftenchoosetouseameasurerelating
totheprioryearsfinancialstatements(e.g.,a
percentageoftotalassets,netincome,or
revenue)toarriveatapreliminaryjudgment
aboutmateriality.Answer(a)isincorrect
becausematerialityisbasedonthemagnitude
ofanomissionormisstatementandnotonthe
initialassessmentofcontrolrisk.Answer(b)is
incorrectbecausewhileanauditorsmateriality
49
judgmentwillaffecttheanticipatedsamplesize
forplannedsubstantivetests,samplesizedoes
notaffectthematerialityjudgment.Answer(d)
isincorrectbecausetheassertionsembodiedin
thefinancialstatementsremainthesamefrom
oneaudittoanother.
20. (b)Therequirementistoidentifythe
mostlikelyeffectofadecreaseinthe
tolerableamountofmisstatement
(tolerablemisstatement)inaclassof
transactions.Answer(b)iscorrect
becauseauditingstandardsstatethat
decreasingthetolerableamountof
misstatementwillrequiretheauditor
todooneormoreofthefollowing:
(1)performauditingprocedures
closertothebalancesheetdate
(answer[b]);(2)selectamore
effectiveauditingprocedure;or(3)
increasetheextentofaparticular
auditingprocedure.Answer(a)is
incorrectbecauseinsucha
circumstancesubstantivetestsare
morelikelytobeperformedator
afterthebalancesheetdatethanprior
tothebalancesheetdate.Answer(c)
isincorrectbecausedecreasingthe
tolerableamountofmisstatementwill
notnecessarilyleadtoanincreasein
theassessedlevelofcontrolrisk.
Answer(d)isincorrectbecausethe
extentofauditingprocedureswillbe
increased,notdecreased.
21. (b)Therequirementistoidentifythe
necessaryconditionforanauditorto
beabletoissueanunqualifiedopin
ion.Answer(b)iscorrectbecauseif
theestimateoflikelymisstatementis
equaltoorgreaterthanamaterial
amountamaterialdeparturefrom
generallyacceptedaccountingprin
ciplesexistsandthusAU508requires
eitheraqualifiedoradverseopinion
insuchcircumstances.Answer(a)is
incorrectbecausetheamountof
knownmisstatement(ifany)neednot
bedocumentedinthemanagement
representationletter.Answer(c)is
incorrectbecauseitordinarilyisnot
necessaryfortheclientto
acknowledgeandrecordimmaterial
knownmisstatements.Answer(d)is
incorrectbecausethetotallikely
misstatementneednotincludethe
adjustingentriesalreadyrecordedby
theclient.
22. (b)Therequirementistodetermine
whichconceptrequiresanattitude
thatincludesaquestioningmindanda
criticalassessmentofauditevidence.
Answer(b)iscorrectbecauseAU230
statesthatprofessionalskepticism
includesthesequalities.Answer(a)is
incorrectbecausedueprofessional
careisabroaderconceptthat
concernswhattheindependent
auditordoesandhowwellheorshe
doesit.Answer(c)isincorrect
becausereasonableassuranceisbased
ontheconceptthatanauditorisnot
aninsurerandhisorherreportdoes
notprovideabsoluteassurance.
Answer(d)isincorrectbecause
supervisioninvolvesthedirectingof
theeffortsofassistantswhoare
involvedinaccomplishingthe
objectivesoftheauditand
determiningwhetherthoseobjectives
wereaccomplished.
23. (c)Therequirementistodetermine
whatpresumptionconcerning
managementshonestythat
professionalskepticismrequires.
Answer(c)iscorrectbecauseprofes
sionalskepticismrequiresthatan
auditorneitherassumedishonestynor
unquestionedhonesty.Answers(a)
and(b)areincorrectbecauseneither
honestyintheabsenceoffraudrisk
factornordishonestyareassumed.
Answer(d)isincorrectbecausethe
conceptofreasonableassuranceisnot
directedtowardsmanagements
honesty.
A.4.
ErrorsandFraud
24. (a)Therequirementistoidentifytheexample
offraudulentfinancialreporting.Answer(a)is
correctbecausefraudulentfinancialreporting
involvesintentionalmisstatementsor
omissionsofamountsordisclosuresinfinancial
statementstodeceivefinancialstatementusers
andchangingtheinventorycounttagsresultsin
suchamisstatement.Answers(b),(c),and(d)
areallincorrectbecausetheyrepresentthe
misappropriationofassets.SeeAU316which
dividesfraudulentactivitiesintomisstatement
arisingfromfraudulentfinancialreportingand
misstatementsarisingfrommisappropriationof
assets(sometimesreferredtoasdefalcation).
25. (b)Therequirementistoidentifythe
bestdescriptionofwhatismeantby
afraudriskfactor.Answer(b)is
correctbecauseAU316suggeststhat
whilefraudriskfactorsdonot
necessarilyindicatetheexistenceof
fraud,theyoftenhavebeenobserved
incircumstanceswherefraudshave
occurred.Answer(a)isincorrect
becausetheriskoffraudmayormay
notbehighwhenariskfactoris
present.Answer(c)isincorrect
becausethecurrentauditprogram
mayinmanycircumstances
appropriatelyaddressafraudrisk
factor.Answer(d)isincorrect
becauseafraudriskfactormayor
maynotrepresentamaterial
weakness.
50
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
incorrectbecausetheyrepresentfactors
consideredintheprofessionalliteraturefor
providingreasonable,andnotabsoluteassur
ance.
26. (a)Therequirementistoidentifythe
replywhichrepresentsanauditor
communicationresponsibilityrelating
30. (b)Therequirementistoidentifythetypeof
tofraud.Answer(a)iscorrect
fraudulentmisstatementthatismostdifficultto
becauseallfraudinvolvingsenior
detect.Answer(b)iscorrectbecause
managementshouldbereported
transactionsthathavenotbeenrecordedare
directlytotheauditcommittee.
generallyconsideredmostdifficultbecause
Answer(b)isincorrectbecause
thereisnogeneralstartingpointfortheauditor
auditorsareonlyrequiredtoreport
intheconsiderationofthetransaction.Answers
fraudtotheSecuritiesandExchange
(a),(c),and(d)allrepresentrecorded
Commissionunderparticular
transactionswhich,whenaudited,areingeneral
circumstances.Answer(c)isincorrect
easiertodetect.
becauseauditorsdonotordinarily
disclosefraudthroughuseofan
31. (d)Therequirementistoidentifytheleast
emphasisofamatterparagraph
likelyindicatorofariskofpossible
addedtotheirreport.Answer(d)is
misstatementduetofraud.Answer(d)iscorrect
incorrectbecauseundercertain
becauseonewouldexpectunusuallyaggressive,
circumstancesauditorsmustdisclose
ratherthanunusuallyconservativeaccounting
fraudoutsidetheentity.
practicestoindicateariskofmisstatementdue
tofraud.Answers(a),(b),and(c)areall
27. (b)Therequirementistoidentifytherisk
incorrectbecausetheyrepresentriskfactors
relatingtomaterialmisstatementthatauditors
explicitlyincludedinAU316,whichprovides
arerequiredtoassess.Answer(b)iscorrect
guidanceonfraud.
becauseSAS109andAU316requireauditors
tospecificallyassesstheriskofmaterial
misstatementsduetofraudandconsiderthat
assessmentindesigningtheauditproceduresto
beperformed.Answer(a)isincorrectbecause
whileSAS109alsorequiresanassessmentof
theoverallriskofmaterialmisstatement
(whethercausedbyerrororfraud)thereisno
requirementtoexplicitlyassesstheriskof
materialmisstatementduetoerrors.Answer(c)
isincorrectbecausetheauditorneednot
explicitlyassesstheriskofmisstatementdueto
illegalacts(seeAU317forinformationon
illegalacts).Answer(d)isincorrectbecauseno
assessmentofbusinessriskisrequired.
28. (a)Therequirementistodetermine
whetherauditsaredesignedto
providereasonableassuranceof
detectingmisstatementsdueto
errors,fraudulentfinancial
reporting,and/ormisappropriation
ofassets.Answer(a)iscorrect
becauseAU110andAU316
requirethatanauditobtain
reasonableassurancethatmaterial
misstatements,whethercausedby
errororfraud,bedetected.
Fraudulentfinancialreportingand
themisappropriationofassetsare
thetwomajortypesoffraudwith
whichanauditisrelevant.
29. (d)Therequirementistoidentifythereply
whichisnotareasonwhyauditorsareunableto
obtainabsoluteassurancethatmisstatements
duetofraudwillbedetected.Answer(d)is
correctbecausewhileanauditormustexercise
professionalskepticismwhenperformingan
audititdoesnotrepresentalimitationthat
makesisimpossibletoobtainabsolute
assurance.Answers(a),(b),and(c)areall
(d)areallincorrectbecausemistakes
intheapplicationofaccounting
principlesorinprocessingdata,and
unreasonableaccountingestimates
arisingfromoversightareexamples
ofmisstatementsratherthanfraud.
32. (c)Therequirementistodetermine
thereplywhichrepresents
informationmostlikelytoaffectthe
auditorsassessmentoftheriskof
misstatementduetofraud.Answer
(c)iscorrectbecauseAU316states
thatmissingdocumentsmaybe
indicativeoffraud.Answer(a)is
incorrectbecausechecksfor
significantamountsarenormally
expectedtobeoutstandingatyear
end.Answer(b)isincorrectbecause
almostallauditsinvolvecomputer
generateddocumentsandtheir
existenceisnotconsidereda
conditionindicatingpossiblefraud.
Answer(d)isincorrectbecausewhile
lastminuteadjustmentsthat
significantlyaffectfinancialresults
maybeconsideredindicativeof
possiblefraud,yearendadjusting
journalentriesalonearetobe
expected.
35. (c)Therequirementistoidentifythe
characteristicmostlikelytoheightenan
auditorsconcernabouttheriskofintentional
manipulationoffinancialstatements.Answer
(c)iscorrectbecausetheplacementof
substantialemphasisonmeetingearnings
projectionsisconsideredariskfactor.Answer
(a)isincorrectbecausehighturnover,notlow
turnover,isconsideredariskfactor.Answer
(b)isincorrectbecauseinsiderpurchasesof
additionalsharesofstockarelesslikelytobe
indicativeofintentionalmanipulationofthe
financialstatementsthanisundueemphasison
meetingearningsprojections.Answer(d)is
incorrectbecausearapidrateofchangeinan
industry,notaslowrate,isconsideredarisk
factor.
33. (a)Therequirementistoidentifythe
mostlikelyresponsetotheauditors
assessmentthattheriskofmaterial
misstatementduetofraudforthe
existenceofinventoryishigh.
Answer(a)iscorrectbecause
observingtestcountsofinventoryon
anunannouncedbasiswillprovide
evidenceastowhetherrecord
inventoryexists.Answer(b)is
incorrectbecausereplacingtest
countswithanalyticalproceduresis
notlikelytobeparticularlyeffective.
Answers(c)and(d)areincorrect
becausetheinventoriesmightwellbe
countedatyearend,allonthesame
date,ratherthanpriortoyearendand
atdifferingdates.
36. (d)Therequirementistoidentifyan
auditorsresponsibilityfordetecting
errorsandfraud.Answer(d)is
correctbecauseAU110requiresthat
anauditordesigntheaudittoprovide
reasonableassuranceofdetecting
misstatementsduetoerrorsand
fraudthatarematerialtothefinan
cialstatements.Answer(a)is
incorrectbecauseauditsprovide
reasonableassuranceofdetecting
materialerrorsandfraud.Answer(b)
isincorrectbecauseitdoesntrestrict
theresponsibilitytomaterialerrors
andfraud.Answer(c)isincorrect
becauseitislessprecisethananswer
(d),whichincludestheAU110
responsibilityonerrorsandfraud.
34. (a)Therequirementistoidentifythe
replythatismostlikelytobean
exampleoffraud.Answer(a)ismost
likely,sincedefalcationisanother
termformisstatementsarisingfrom
misappropriationofassets,amajor
typeoffraud.Answers(b),(c),and
37. (d)Therequirementistoidentifythe
circumstancesinwhichanauditor
mayhavearesponsibilitytodisclose
fraudtopartiesotherthanaclients
seniormanagementanditsaudit
committeeorboardofdirectors.
Answer(d)iscor
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
rectbecauseAU316statesthatsucha
responsibilitymayexisttotheSECwhenthere
hasbeenanauditorchangetoasuccessor
auditorortocomplywithSEC1995Private
SecuritiesReformActcommunication
requirement,whenthesuccessorauditormakes
inquiries,andtoagovernmentagencyfrom
whichtheclientreceivesfinancialassistance.
Inaddition,thatsectionstatesthatanauditor
mayhavesuchadisclosureresponsibilityin
responsetoasubpoena,acircumstancenot
consideredinthisquestion.
38. (b)Errorsrefertounintentional
mistakesinfinancialstatements
suchasmisinterpretationoffacts.
Answers(a),(c),and(d)all
representfraudwhicharedefinedas
intentionaldistortionsoffinancial
statements.
39. (d)Therequirementistoidentifythe
levelofassuranceanauditor
provideswithrespecttodetectionof
materialerrors,fraud,anddirect
effectillegalacts.Answer(d)is
correctbecauseAU110requiresthe
auditortodesigntheaudittoprovide
reasonableassuranceofdetecting
materialerrors,fraudanddirecteffect
illegalacts.(Adirecteffectillegal
actisonethatwouldhaveaneffect
onthedeterminationoffinancial
statementamounts.)
40. (c)Therequirementistoidentifytheproper
attitudeofanauditorwhoisperformingan
auditinaccordancewithgenerallyaccepted
auditingstandards.Answer(c)iscorrect
becausetheauditorshouldplanandperformthe
auditwithanattitudeofprofessional
skepticism,recognizingthattheapplicationof
theauditingproceduresmayproduceevidence
indicatingthepossibilityofmisstatementsdue
toerrorsorfraud.Answer(a)isincorrect
becausewhiletheCPAmustexhibitobjective
judgment,professionalskepticismmore
accuratelysummarizestheproperattitude
duringanaudit.Answer(b)isincorrectbecause
whileaCPAmustbeindependentandhave
integrity,thisisnottheattitudeusedtoplan
andperformtheaudit.Answer(d)isincorrect
becausetheauditisnotplannedandperformed
withimpartialconservatism.
41. (c)Therequirementistoidentifythemeaning
ofthetermmaterialmisstatementwhenused
intheprofessionalstandards.Answer(c)is
correctbecauseSAS107and
AU316statethatamaterialmisstatementmay
occurduetoerrors,fraud,andillegalactswith
adirecteffectonfinancialstatementamounts.
42. (d)Therequirementistoidentifyan
auditorsresponsibilityfordetecting
financialstressofemployeesor
51
adverserelationshipsbetweena
companyanditsemployees.Answer
(d)iscorrectbecauseAU316states
that,whiletheauditorisnotrequired
toplantheaudittodiscoverinforma
tionthatisindicativeoffinancial
stressofemployeesoradverse
relationshipsbetweenthecompany
anditsemployees,suchconditions
mustbeconsideredwhenanauditor
becomesawareofthem.Answers(a),
(b),and(c)areallincorrectbecause
theauditordoesnotplantheauditto
detecttheseconditions.
43. (a)Therequirementistoidentifyan
auditorsresponsibilitywhenheor
shebelievesthatamisstatementisor
maybetheresultoffraud,butthat
theeffectofthemisstatementsis
immaterialtothefinancial
statements.Answer(a)iscorrect
becauseAU316statesthatinsuch
circumstancestheauditorshould
evaluatetheimplicationsofthefraud,
especiallythosedealingwiththe
organizationalpositionofthe
person(s)involved.
44. (a)Therequirementistoidentifythe
correctstatementsrelatingtothe
auditorsconsiderationoffraud.An
swer(a)iscorrectbecauseAU316
statesthattheauditorsinterest
relatestofraudulentactsthatcausea
materialmisstatementoffinancial
statements.Answer(b)isincorrect
becauseerrorsareunintentional.
Answer(c)isincorrectbecause
frauddoesnotnecessarilyinvolve
themisappropriationofassets(it
mayinvolvefraudulentfinancialre
porting).Answer(d)isincorrect
becauseanauditormustdesignan
audittoobtainreasonableassurance
ofdetectingmisstatements,
regardlessofwhethertheyare
causedbyerrorsorfraud.
45. (a)Therequirementistoidentifythefactoror
conditionthatanauditisleastlikelytobe
plannedtodiscover.Answer(a)iscorrect
becauseitrepresentsafinancialstress,and
auditorsarenotrequiredtoplanauditstodis
coverinformationthatisindicativeoffinancial
stressofemployeesoradverserelationships
betweentheentityanditsemployees.Answers
(b),(c),and(d)areallincorrectbecausethey
representexamplesofriskfactorsthatshould
beconsideredinanauditandareincludedin
AU316.
46. (a)Therequirementistodetermine
whenauditriskfactorsmaybe
identified.Answer(a)iscorrect
becauseAU316statesthatfraudrisk
factorsmaybeidentifiedduring
planning,obtaininganunderstanding,
orwhileconductingfieldwork;in
addition,theymaybeidentifiedwhile
consideringacceptanceor
continuanceofclientsand
engagements.
47. (b)Therequirementistoidentifythe
circumstanceinwhichitismost
likelythatmanagementsattitude
towardaggressivefinancialreporting
andtowardmeetingprojectedprofit
goalswouldmostlikelysignificantly
influenceanentityscontrol
environment.Answer(b)iscorrect
becausewhenmanagementis
dominatedbyoneindividual,thatin
dividualmaybeabletofollowoverly
aggressiveaccountingprinciples.
48. (d)Therequirementistoidentifythe
procedureleastlikelytoberequired
onanaudit.Answer(d)is
correctbecausefraudisabroadlegal
conceptandauditorsdonotmake
legaldeterminationsofwhetherfraud
hasoccurred.Answers(a),(b),and
(c)areincorrectbecauseconsidering
journalentries,estimates,andunusual
transactionsareordinarilyrequired
auditprocedurestoaddresstheriskof
managementoverrideofcontrols.
SeeAU316forinformationonthe
auditorsresponsibilityforthe
considerationoffraudinafinancial
statementaudit.
49. (b)Therequirementistoidentifythemost
likelyresponsewhenariskoffraudhasbeen
identifiedonanaudit.Answer(b)iscorrect
becauseAU316indicatesthatoverall
responsestotheriskofmaterialmisstatements
duetofraudinclude(1)assigningpersonnel
withparticularskillsrelatingtotheareaand
consideringthenecessaryextentofsupervision
totheaudit,(2)increasingtheconsiderationof
managementsselectionandapplicationof
accountingprinciples,and(3)makingaudit
procedureslesspredictable.Answer(a)is
incorrectbecauseclosersupervision,notless
closesupervision,ismorelikelytobe
appropriate.Answer(c)isincorrectbecause
individualswithspecializedskillsmaybe
neededwhoarenotCPAs.Answer(d)is
incorrectbecausesubjectivetransactions(e.g.,
accountingestimates)oftenprovidemorerisk
thanobjectivetransactions.
52
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
fraudulentfinancialreporting.
50. (a)Therequirementistoidentify
theleastlikelyinquiryof
managementrelatingtoidentifying
theriskofmaterialmisstatement
duetofraud.Answer(a)iscorrect
becausefinancialoperationsof
manycompaniesarenotordinarily
controlledbyandlimitedtoone
location.Answers(b),(c),and(d)
areallincorrectbecausetheyarein
cludedinAU316asinquiriesthat
shouldbemadeofmanagement.
51. (a)Therequirementistoidentifythe
attributesordinarilypresentwhen
individualscommitfraud.Answer(a)
iscorrectbecauseAU316suggests
thatthethreeconditionsgenerally
presentwhenfraudoccursarethat
individualshavean(1)incentiveor
pressure,(2)opportunity,and(3)
abilitytorationalize.Answers(b),(c),
and(d)areallincorrectbecausethey
suggestthatoneofthethreeelements
isnotordinarilypresent.
52. (a)Therequirementistodetermine
anauditorsreportingresponsibility
whenheorshehasdiscoveredthat
managementisinvolvedina
financiallyimmaterialfraud.Answer
(a)iscorrectbecauseAU316
requiresthatallmanagementfraud,
regardlessofmateriality,bereported
totheauditcommittee.Answer(b)is
incorrectbecausefraudisnotdirectly
reportedtothePublicCompany
AccountingOversightBoard.Answer
(c)isincorrectbecauseifanything,in
additiontotheauditcommittee,the
fraudisreportedtoalevelof
managementatleastonelevelabove
thoseinvolvedinafraud.Answer(d)
isincorrectbecausethereisa
reportingresponsibilityfor
financiallyimmaterialmanagement
fraud.
53. (c)Therequirementistoidentifythe
mostlikelyriskfactorrelatingto
fraudulentfinancialreporting.An
swer(c)iscorrectbecausenegative
cashflowsfromoperationsmay
resultinpressureuponmanagement
tooverstatetheresultsofoperations.
Answer(a)isincorrectbecauseone
wouldexpectacompanystop
executivestodominatemanagement
dominationbyoneorafewmight
beconsideredariskfactor.Answers
(b)and(d)areincorrectbecauselarge
amountsofcashbeingprocessedand
smallhighdollarinventoryitemsare
moredirectlyrelatedtothemisappro
priationofassetsthantheyareto
54. (b)Therequirementistoidentifythe
mostlikelyfraudriskfactoronan
audit.Answer(b)iscorrectbecause
thepossibilityofimproperrevenue
recognitionisordinarilypresumedon
audits.Answers(a),(c),and(d)all
representpotentialrisks,butrisks
thatarenotordinarilypresumedon
anaudit.SeeAU316forinformation
ontheauditorsresponsibilityfor
theconsiderationoffraudina
financialstatementaudit.
55. (d)Therequirementistoidentifythe
circumstancesrelatingtothediscoveryofthe
paymentofsmallbribestomunicipalofficials
thatismostlikelytocauseanauditorto
withdrawfromanengagement.Answer(d)is
correctbecauseAU317statesthat
managementfailuretotaketheappropriate
remedialactionisparticularlyproblematical
sinceitmayaffecttheauditorsabilitytorely
onmanagementrepresentationandmay
thereforeleadtowithdrawal.Answers(a),(b),
and(c)allrepresentcircumstanceswhichthe
auditorwillconsider,butarenotordinarily
consideredasseriousasfailuretotakethe
appropriateremedialaction.
56. (d)Therequirementistoidentifythefactormost
likelytocauseaCPAnottoacceptanewaudit
engagement.Answer(d)iscorrectbecauseapart
oftheunderstandinganauditormustobtainwitha
clientisthatmanagementisresponsiblefor
makingallfinancialrecordsandrelatedinfor
mationavailable(seeSAS108).Accordingly,if
theclientrefusestomakesuchinformation
availabletheauditorisunlikelytoaccepttheaudit
client.Answer(a)isincorrectbecausea
circumstanceimposedscopelimitationssuchas
completionofthephysicalinventorycountresults
inasituationinwhichtheauditormayconsider
usingalternativeprocedures(includingmaking
sometestcounts)todeterminewhetherinventory
countsareproper.Answer(b)isincorrectbecause
anauditormayobtainanunderstandingofthe
clientsoperationsandindustrywhileperforming
theaudit.Answer(c)isincorrectbecausewhilea
reviewofthepredecessorauditorsworking
papersisordinarilydesirable,itisnotrequired.
57. (d)Therequirementistoidentifythefactor
mostlikelytoheightenanauditorsconcern
abouttheriskoffraudulentfinancialreporting.
Answer(d)iscorrectbecauseAU316,which
presentsavarietyofriskfactors,suggeststhat
anoverlycomplexorganizationalstructureis
suchariskfactor.Answer(a)isincorrect
becauselargeamountsofliquidassetsthatare
easilyconvertibleintocashrepresentmoreofa
riskrelatingtomisappropriationofassetsrather
thantofraudulentfinancialreporting.Answer
(b)isincorrectbecausehighgrowth,rather
thanlowgrowth,isconsideredariskfactor.
Answer(c)isincorrectbecauseonewould
expectfinancialmanagementsparticipationin
theinitialselectionofaccountingprinciples.
A.5.
IllegalActs
58. (c)Therequirementistoidentifythe
situationinwhichanauditorwouldbe
mostlikelytowithdrawfroman
engagementwhenheorshehas
discoveredthataclientsemployees
havepaidsmallbribestopublic
officials.Answer(c)iscorrect
becauseAU317statesthat
resignationshouldbeconsidered
whenanillegalactdoesnotreceive
properremedialaction,becausesuch
inactionmayaffecttheauditors
abilitytorelyonmanagement
representationsandtheeffectsof
continuedassociationwiththeclient.
Answer(a)isincorrectbecausethe
receiptoffederalfundsinsucha
situationisnotaslikelytoresultin
auditorwithdrawalasisanswer(c).
Answer(b)isincorrectbecauseit
seemsinconsistentwiththepremise
ofthequestioninthat,ifnoevidence
exists,theauditorisunlikelytoknow
thatbribeshavebeenpaid.Answer
(d)isincorrectbecausesuchsmall
bribeswillnotordinarilyneedtobe
disclosed.Alternatively,iftheauditor
believesthatthereissuchaneed,the
lackofsuchdisclosurerepresentsa
departurefromgenerallyaccepted
accountingprinciplesandeithera
qualifiedoradverseopinionis
appropriate.
59. (b)Therequirementistoidentifythe
illegalactthatanauditshouldbe
designedtoobtainreasonableassurance
ofdetecting.Answer(b)iscorrect
becausetheaccrualandbillingofan
improperamountofrevenueunder
governmentcontractsisanillegalact
withadirecteffectonthedetermi
nationoffinancialstatementamounts,
andauditsaredesignedtodetectsuch
illegalacts.Answers(a),(c),and(d)
areallincorrectbecausetheyrepresent
illegalactswithanindirectfinancial
statementeffectandanauditprovides
noassurancethatsuchactswillbe
detectedorthatanycontin
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
gentliabilitiesthatmayresultwillbedisclosed.
See
AU317fordetailedguidanceonauditor
responsibilitywithrespecttodirectand
indirectillegalacts.
60. (a)Therequirementistoidentifythe
smallmisstatementthatismostlikely
tohaveamaterialeffectonan
entitysfinancialstatements.Answer
(a)iscorrectbecauseanillegal
paymentofanotherwiseimmaterial
amountmaybematerialifthereisa
reasonablepossibilitythatitmaylead
toamaterialcontingentliabilityora
materiallossofrevenue.
61. (c)Therequirementistodeterminewhatan
auditormightreconsiderwhenaclientsboard
ofdirectorshasrefusedtotakeanyaction
relatingtoanauditorsdisclosurethatthe
companyhasmadeimmaterialillegal
contributions.Answer(c)iscorrectbecausein
suchacircumstancethefailuretotakeremedial
actionmaycauseanauditortodecrease
relianceonmanagementrepresentations.
Answer(a)isincorrectbecausethereplybythe
attorneyislikelytodiscloseanyclaims,
litigationorassessmentsthattheclienthas
improperlyomittedfromtheletterofaudit
inquiry.Answer(b)isincorrectbecausethe
prioryearsauditprogramsarenotbeingrelied
uponforthisyearsaudit.Answer(d)is
incorrectbecausethepreliminaryjudgment
aboutmaterialitylevelswouldnotbeexpected
tochange.
62. (b)Therequirementistoidentifya
reasonwhyauditscannotreasonably
beexpectedtobringallillegalactsto
theauditorsattention.Answer(b)is
correctbecauseillegalactsrelatingto
theoperatingaspectsofanentityare
oftenhighlyspecializedandcomplex
andoftenarefarremovedfromthe
eventsandtransactionsreflectedin
financialstatements.Answer(a)is
partiallycorrectsincemanagement
overriderepresentsalimitationofthe
effectivenessofinternalcontrol.Yet,
auditorsaremorelikelytoidentify
suchtransactionsbecausetheyrelate
toeventsandtransactionsreflectedin
thefinancialstatements.Answer(c)
isincorrectbecausemanyillegalacts
arenotsubjecttotheclientsinternal
control.Answer(d)isincorrect
becauseillegalactsmaybe
perpetratedwithoutaccesstoboth
assetsandaccountingrecords.
63. (a)Therequirementistodetermine
anauditorsresponsibilitywhen
informationcomestohis/her
attentionthatimpliestheexistence
ofpossibleillegalactswithama
53
terial,butindirecteffectonthe
financialstatements.Answer(a)is
correctbecauseAU317requiresthe
auditortoapplyauditprocedures
specificallydesignedtodetermine
whetheranillegalacthasoccurred
whensuchinformationcomesto
his/herattention.Answers(b),(c),
and(d)areallincorrectbecausethey
representprocedurestheauditor
wouldperformafterinitial
procedureshadconfirmedthe
existenceofthepossibleillegal
act(s).
64. (b)Therequirementistodetermine
thecircumstanceinwhichitismost
likelythataCPAwouldwithdraw
fromanauditengagementafter
havingdiscoveredthatclient
employeeshavecommittedanillegal
act.Answer(b)iscorrectbecausethe
auditormayconcludethatwithdrawal
isnecessarywhentheclientdoesnot
taketheremedialaction,evenwhen
theillegalactisnotmaterialtothe
financialstatements.Answers(a)and
(c)areincorrectbecausewhether
generallyacceptedaccounting
principleshavebeenviolatedand
whethertheillegalactoccurred
duringaprioryearthatwasnot
auditedmayormaynothaveaneffect
on
thedecisiontowithdrawfromtheengagement.
Answer(d)isincorrectbecausetheassessed
levelofcontrolriskwillnothaveadirect
relationshiponthedecisiontowithdrawfrom
theengagement.
65.(b)TherequirementistoidentifyaCPAs
responsibilityundertheSecuritiesLitigation
ReformActof1995foruncorrectedillegalacts
whichhavebeencommunicatedtotheboardof
directorswhichrefusestoinformtheSECof
theirexistence.Answer(b)iscorrectbecause
CPAsarerequiredunderthelawtodelivera
reportonthoseillegalactstotheSECwithin
onebusinessdayinsuchcircumstances.
Answer(a)inincorrectbecausethereisnore
quirementtoresign,althoughtheauditormay
decidetodoso.Answer(c)isincorrectbecause
theActsetsupreportingtotheSEC,nottothe
stockholders.Answer(d)isincorrectbecause
withholdingoftheauditopinionisnot
suggestedintheAct.
B. AuditPlanning
reporting,andmanagementsdisregardinthis
areamayleadtheCPAtorejectthe
engagement.Answer(a)isincorrectbothbe
causeaCPAmaynotneedanunderstandingof
theprospectiveclientsinternalauditors
computerassistedaudittechniquetoforman
opiniononthefinancialstatements,and
becauseifsuchunderstandingisnecessary,it
canbeobtainedsubsequenttoengagement
acceptance.Answer(c)isincorrectbecauseAU
334indicatesthataCPAoftenwillbeunableto
determinewhetherrelatedpartytransactions
wereconsummatedontermsequivalentto
armslengthtransactions.Answer(d)is
incorrectbecausewhilemanagementsrefusal
topermittheperformanceofsubstantivetests
beforetheyearendmaypresentaproblem,the
auditormaybeabletoeffectivelyperformsuch
testsafteryearend.
B.1.CommunicatewithPredecessor
Auditors(PriortoEngagement
Acceptance)
68. (d)Therequirementistoidentifya
requirementpriortoacceptingan
engagementtoauditanewclient.
Answer(d)iscorrectbecauseAU
315requiresthatanauditorattempt
toobtainclientpermissiontocontact
thepredecessorpriortoacceptinga
newengagement.Answers(a),(b),
and(c)areincorrectbecausethey
mayallbeobtainedsubsequentto
acceptinganengagement.
66. (c)Therequirementistoidentifytheprocedure
leastlikelytobeconsideredanauditplanning
procedure.Answer(c)iscorrectbecause
performingtheriskassessmentoccurs
subsequenttoauditplanning.Answer(a)is
incorrectbecauseanengagementletterisused
toestablishanunderstandingwiththeclient,
andthisisaplanningprocedure.Answer(b)is
incorrectbecauseauditorsdeveloptheoverall
auditstrategyduringauditplanning.Answer(d)
isincorrectbecausetheauditplanisdeveloped 69. (a)Therequirementistodeterminethenature
duringplanning.
oftheinquiriesthatasuccessorauditorshould
makeofthepredecessorauditorpriorto
67. (b)Therequirementistoidentifythefactor
acceptinganauditengagement.Answer(a)is
mostlikelytocauseaCPAtodecidenotto
correctbecausetheinquiriesshouldinclude
acceptanewauditengagement.Answer(b)is
specificquestionstomanagementon(1)
correctbecauseacertainlevelofinternal
disagreementswith
controlisessentialforfinancialstatement
54
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
managementastoauditingproceduresand
accountingprinciples(reply[a]),(2)factsthat
mightbearontheintegrityofmanagementand
(3)thepredecessorsunderstandingastothe
reasonsforthechangeofauditors.Answers
(b),(c),and(d)areincorrectbecause,ifmade
atall,theywillbeaftertheengagementhas
beenaccepted.
70.(b)Therequirementistoidentifythe
correctstatementregardingasuccessor
auditorsinquiriesofthepredecessorauditor.
Answer(b)iscorrectbecausethesuccessor
shouldrequestinformationsuchas(1)facts
thatmightbearontheintegrityof
management,(2)disagreementswith
managementastoaccountingprinciples,
auditingprocedures,orothersignificant
matters,and(3)thepredecessors
understandingofthereasonsforthechangeof
auditors.Answers(a),(c),and(d)allrelateto
mattersnotrequiredtobediscussedpriorto
acceptinganauditengagement.
B.2.EstablishinganUnderstandingwith
theClient(EngagementLetters)
71. (b)Therequirementistoidentifytheitem
ordinarilyincludedwhenanauditorestablishes
anunderstandingwithaclientregardingthe
servicestobeperformed.Answer(b)iscorrect
becauseauditingstandardsrequirethatan
auditorensurethattheauditcommitteeisaware
ofanysignificantdeficiencieswhichcometo
theCPAsattention.Answer(a)isincorrect
becausewhileanunderstandingwillincludea
statementthatmanagementisresponsiblefor
theentitysfinancialstatements,anexplicit
statementabouterrorsandillegalactivitiesof
employeesisnotordinarilyincluded.Answer
(c)inincorrectbecausemanagementdoesnot
providetheauditorwithanassessmentofthe
riskofmaterialmisstatementduetofraud.
Answer(d)isincorrectbecausenosuch
statementaboutanauditorsresponsibilityfor
determiningpreliminaryjudgmentsabout
materialityandauditriskfactorsisordinarily
includedinestablishinganunderstanding.See
SAS108forinformationonestablishingan
understandingwithaclient.
72. (a)Therequirementistoidentifythe
mattergenerallyincludedinan
auditorsengagementletter.Answer
(a)iscorrectbecauseAU310,which
outlinesrequirementsforengagement
letters,indicatesthatanengagement
lettershouldincludeanindicationthat
managementisresponsiblefor
identifyingandensuringthatthe
companycomplieswiththelawsand
regulationsapplicabletoitsactivities.
Answer(b)isincorrectbecausesuch
detailedinformationonmaterialityis
notgenerallyincludedinan
engagementletter.Answer(c)is
incorrectbecausemanagement
liability(ifany)forillegalacts
committedbyemployeesisnotgener
allyincludedinanengagementletter.
Answer(d)isincorrectbecause
whileanauditorisrequiredtoobtain
anunderstandingofinternalcontrol,
heorsheisnotrequiredtosearchfor
significantinternalcontrol
deficiencies.
73. (c)Therequirementistoidentifythe
mostlikelyprocedureduringthe
initialplanningphaseofanaudit.An
swer(c)iscorrectbecauseduring
initialplanningthetimingof
procedureswillbediscusseddueto
theneedforclientassistancewith
manyoftheseprocedures.Answer
(a)isincorrectbecausethetimingof
auditprocedureswilloccur
subsequenttotheinitialplanning
stageofanaudit.Answer(b)is
incorrectbecausetheevaluationof
reasonablenessoftheclients
accountingestimateswilloccurafter
planning(seeAU342).Answer(d)is
incorrectbecausetheinquiryofa
clientsattorneywilloccur
swer(c)iscorrectbecauseAU311,
whichprovidesinformationon
obtaininganunderstandingwiththe
client,doesnotsuggestany
arrangementconcerningCPA
investmentinclientsecurities;indeed
suchinvestmentsareprohibitedby
theCodeofProfessionalConduct.
Answers(a),(b),and(d)allrepresent
arrangementswhichAU311suggests
maybeincludedinanengagement
letter(orotherformofunderstanding
withaclient).
subsequentlytoinitialplanning(seeAU337).
SeeSAS108forinformationonplanning.
74.(d)Therequirementistoidentifythe
statementthatisleastlikelytoappearinan
auditorsengagementletter.Answer(d)is
correctbecauseauditorsordinarilywillnot
discusswithmanagementthedetailsof
proceduresthatarenecessarytoperformthe
audit.Answers(a),(b),and(c)areincorrect
becauseengagementletterswillincludeastate
mentontheriskofnotdetectingmaterial
errorsandfraud,andmayincludeinformation
onfeesandobservedopportunitiesfor
economy.
B.3.
PreliminaryEngagementActivities
78. (b)Therequirementistoidentifyform(s)of
documentationoftheunderstandingobtained
75. (c)Therequirementistoidentifytheitemfor
withaclient.Answer(b)iscorrectbecausethe
whichthegenerallyacceptedauditingstandards
professionalstandardsrequirethatanauditor
donotrequiredocumentation.Answer(c)is
documenttheunderstandingthroughawritten
correctbecausewhileaCPAfirmwillinclude
communicationwiththeclient.Answer(a)is
anengagementletterintheworkingpapers,it
incorrectbecauseanoralcommunicationisnot
willnotdetailtheauditorsplannedfieldwork.
sufficient.Answer(c)isincorrectbecausethe
Answer(a)isincorrectbecauseSAS108
communicationshouldbeinwriting.Answer
requiresawrittenauditplan.Answer(b)is
(d)isincorrectbecausetheunderstandingisnot
incorrectbecauseSAS103requiresthatthe
documentedinacompletelydetailedauditplan
workingpapersdocumenttheagreementor
atermofquestionablemeaning.
reconciliationoftheaccountingrecordswith
thefinancialstatements.Answer(d)isincorrect
79. (c)Therequirementistoidentifythe
becauseSAS109requirestheauditorto
factorthatmostlikelywould
documenttheassessmentoftherisksof
influenceanauditorsdetermination
materialmisstatement.
oftheauditabilityofanentitys
76. (a)Therequirementistodetermine
whattypesofitemsareordinarily
includedinanengagementletterin
additiontotheobjectivesofthe
engagement.Answer(a)iscorrect
becauseSAS108alsorequires
inclusionofinformationonCPA
responsibilities,client
responsibilities,andlimitationsofthe
engagement.
77. (c)Therequirementistodetermine
thereplywhichisleastlikelytobe
includedinanengagementletter.An
financialstatements.Answer(c)is
correctbecauseinadequate
accountingrecordsmaycausean
auditortoconcludethatitisunlikely
thatsufficientappropriateevidence
willbeavailabletosupportan
opiniononthefinancialstatements;
accordingly,anauditormay
determinethatthefinancial
statementsarenotauditable.Answer
(a)isincorrectbecauseanauditor
shouldbeabletoobtainthe
knowledgenecessarytoaudita
complex
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
B.5.
accountingsystem.Answer(b)isincorrect
becausewhilerelatedpartytransactionsmay
raisetransactionvaluationissuesduetothe
lackofanarmslengthtransaction,the
problemisnormallynotsosevereastomake
theentitynotauditable.Answer(d)is
incorrectbecausealackofoperating
effectivenessofcontrolsmayoftenbe
overcomethroughanincreaseinthescopeof
substantivetests.
B.4.
DevelopinganOverallStrategy
80. (a)Therequirementistoidentifythe
areathatismostlikelytorequire
specialauditplanningconsiderations.
Answer(a)iscorrectbecausean
inventorycomprisedofdiamond
ringsislikelytorequirethatthe
auditorplanaheadtoinvolvea
specialisttoassistinvaluationissues.
Answer(b)isincorrectbecause
valuationofanassetsuchasanew
copymachineisnotordinarily
expectedtoprovidevaluation
difficulties.Answer(c)isincorrect
becausetheexpensingpurchasesof
suchsmallassetsisordinarilyac
ceptableduetotheimmaterialityof
thetransactions.Answer(d)is
incorrectbecauseaccelerated
depreciationmethodsareordinarily
acceptable.
81. (b)Therequirementistoidentifythe
informationsourcethataCPAwould
mostlikelyconsultforinformationon
howvariouspubliclyheldcompanies
havecompliedwiththedisclosure
requirementsofanewfinancial
accountingstandard.Answer(b)is
correctbecauseAICPA
AccountingTrendsandTechniques,
whichisissuedannually,summarizes
suchdisclosuresof600industrialand
merchandisingcorporations.Answer(a)
isincorrectbecausetheAICPA
CodificationofStatementsonAuditing
Standardscodifiesthevarious
StatementsonAuditingStandardsand
doesnotincludeinformationon
individualcompanycompliancewith
disclosurerequirements.Answer(c)is
incorrectbecauseQualityControl
Reviewstandardsareestablishedbythe
AICPAandbecausetheydonotinclude
informationonindividualcompany
compliancewithdisclosure
requirements.Answer(d)isincorrect
becauseForm10Kitselfprovides
informationonpreparingForm10Kand
thisformdoesnotincludeinformation
onindividualcompanycompliancewith
disclosurerequirements.
TheAuditPlan
55
82. (c)Therequirementistodeterminewhyan
auditorshoulddesignawrittenauditprogram.
Answer(c)iscorrectbecauseanauditprogram
setsforthindetailtheauditproceduresthatare
necessarytoaccomplishtheobjectivesofthe
audit.Answer(a)isincorrectbecauseaudit
programsaddresstopicsbeyondselecting
materialtransactionsandthisisnottheirprimary
focus.Answer(b)isincorrectbecauseaprogram
mayincludenumeroussubstantiveteststobeper
formedpriortothebalancesheetdate.Answer(d)
isincorrectbecauseimmaterialaccountsoftenare
nottestedandbecausetestsoftransactions,tests
ofbalances,andanalyticalproceduresareusedto
testaccountbalances;accountbalancesarenot
directlytestedthroughtestsofcontrols.
83. (a)Therequirementistodeterminea
pointatwhichanauditprogrammay
befinalized.Answer(a)iscorrect
becausetheconsiderationofinternal
controlhelpstheauditortoassess
controlriskandtoplantheaudit:
accordingly,theauditprogramisnot
generallyfinalizedpriortothecon
siderationofinternalcontrol.Answer
(b)isincorrectbecause,while
generallydesirable,engagement
lettersarenotrequiredonaudits.
Answer(c)isincorrectbecause
report
ableconditionsmaybecommunicatedatvarious
timessubsequenttofinalizationoftheaudit
program.Answer(d)isincorrectbecauseaudit
programsareoftenfinalizedpriortothe
performanceofthesearchforunrecorded
liabilities.
acceptableforacontinuingclient.
Also,whenanewclienthasengaged
anauditorpriortoyearend,aportion
oftheauditmaybeconductedpriorto
yearend.Answer(b)isincorrect
becauseanengagementmaybe
acceptedaftertheclientsyearend.
Answer(c)isincorrectbecause
alternativeproceduresmaybe
possiblewhenaninventorycountwas
notobservedatyearend.Answer(d)
isincorrectbecausefinalstaffing
decisionsneednotbemadepriorto
completionoftheplanningstageof
audits.
84. (d)Therequirementistodeterminethemanner
inwhichauditprogramsshouldbedesigned.
Answer(d)iscorrectbecauseanauditprogram
shouldbedesignedsothattheauditevidence
gatheredissufficienttosupporttheauditors
conclusions.Answer(a)isincorrectbecause,
often,mostauditprocedureswillnotbe
performedasinterimwork.Answer(b)is
87. (d)Therequirementistoidentifytheelement
incorrectbecauseinherentriskneednotbe
oftheauditplanningprocessmostlikelytobe
assessedatalowlevel.Answer(c)isincorrect
agreeduponwiththeclientbefore
becausewhileprovidingconstructive
implementationoftheauditstrategy.Answer
suggestionstomanagementisdesirable,the
(d)iscorrectbecausetheauditorwillordinarily
auditprogramisnotbasedondevelopingcon
observethecountingofinventoryandthiswill
structivesuggestions.
requireadegreeofcoordinationbetweenthe
85. (d)Therequirementistodetermine
performanceofauditproceduresandclient
whatspecificauditobjectivesare
countprocedures.Answer(a)isincorrect
addressedwhendesigninganaudit
becausetheclientwillnotdeterminethe
program.Answer(d)iscorrect
evidencetobegatheredtoprovideasufficient
becauseinobtainingevidencein
basisfortheauditorsopinion.Answers(b)
supportoffinancialstatement
and(c)areincorrectbecausetheseprocedures
assertions,theauditordevelops
willbedeterminedsubsequentto
specificauditobjectivesinthelightof
implementationoftheauditstrategy.
thoseassertions.Answers(a),(b),
C. Obtain an Understanding of
and(c)areallincorrectbecausethese
the Entity and Its
repliesdonotrelatespecificallytothe
Environment
auditobjectivesasdothefinancial
statementassertions.
88.(b)Therequirementistodeterminethe
mannerinwhichanauditorplansanauditofa
B.7. TimingofAuditProcedures
continuingclient.Answer(b)iscorrect
86. (a)Therequirementistoidentifythe
becauseareviewofprioryearworkingpapers
statementthatisalwaystruewith
andthepermanentfilemayprovideuseful
respecttoplanninganaudit.Answer
informationaboutthenatureofthebusiness,
(a)iscorrectbecauseitisacceptable
organizationalstructure,operating
foranauditortoperformacertain
characteristics,andtransactionsthatmay
portionoftheauditataninterimdate;
requirespecialattention.Answer(a)is
forexample,performingaportionof
incorrectbecausetestsofdetailsoftransactions
planningpriortoyearendisalways
andbalancesoccursubsequent
56
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
toplanning.Answer(c)isincorrectbecause
whilereadingspecializedindustryjournalswill
helptheauditortoobtainabetter
understandingoftheclientsindustry,itis
likelytobelesshelpfulthanreviewingthe
workingpapers.Answer(d)isincorrect
becauseareevaluationoftheclientsinternal
controlenvironmentoccurssubsequenttothe
ordinalplanningoftheaudit.
89. (a)Therequirementistodeterminewho,ata
minimum,musthaveknowledgeofthe
relevantprofessionalaccountingandauditing
standardswhenanauditisbeingperformed.
Answer(a)iscorrectbecauseAU230requires
that,ataminimum,theauditorwithfinal
responsibilityhavesuchknowledge.Answers
(b),(c),and(d)areallincorrectbecausethey
suggestahigherminimumrequirement.
90. (d)Therequirementistodetermine
whyanauditorobtainsknowledge
aboutanewclientsbusinessandits
industry.Answer(d)iscorrect
becauseobtainingalevelof
knowledgeoftheclientsbusiness
andindustryenablestheCPAto
obtainanunderstandingoftheevents,
transactions,andpracticesthat,inthe
CPAsjudgment,mayhaveasig
nificanteffectonthefinancial
statements.Answer(a)isincorrect
becauseprovidingconstructive
suggestionsisasecondary,andnot
theprimary,reasonforobtaining
knowledgeaboutaclientsbusiness
andindustry.Answer(b)isincorrect
becausewhileaCPAmustdevelop
anattitudeofprofessionalskepticism
concerningaclient,thisattitudeisnot
obtainedbyobtainingknowledge
abouttheclientsbusinessand
industry.Answer(c)isincorrect
becauseinformationonthebusiness
andindustryofaclientwillprovide
onlylimitedinformationin
determiningwhetherfinancial
statementsaremateriallymisstated,
andnumerousotherfactorsare
consideredinevaluatingaudit
findings.
91. (c)Therequirementistoidentifythe
leastlikelyproceduretobe
performedinplanningafinancial
statementaudit.Answer(c)iscorrect
becauseselectingasampleof
vendorsinvoicesforcomparisonto
receivingreportswilloccurnormally
asapartoftheevidence
accumulationprocess,notasapart
oftheplanningofanaudit.Answer
(a)isincorrectbecausecoordination
oftheassistanceofentitypersonnel
indatapreparationoccursduring
planning.Answer(b)isincorrect
becausewhileplanningtheaudit,
CPAsmaydiscussmattersthataffect
theauditwithfirmpersonnel
responsibleforprovidingnonaudit
servicestotheentity.Answer(d)is
incorrectbecauseanyavailable
currentyearinterimfinancial
statementswillbereadduringthe
planningstage.
C.1.CommunicatewithPredecessor
Auditors(Subsequentto
EngagementAcceptance)
92. (a)Therequirementistoidentify
whetherapredecessorauditorshould
permitasuccessorauditortoreview
workingpaperanalysesrelatingto
contingencies,balancesheet
accounts,orboth.Answer(a)is
correctbecauseAU315statesthata
predecessorauditorshouldordi
narilypermitthesuccessortoreview
workingpapers,including
documentationofplanning,internal
control,auditresults,andother
mattersofcontinuingaccountingand
auditingsignificance,suchasthe
workingpaperanalysisofbalance
sheetaccountsandthoserelatingto
contingencies.
93. (d)Therequirementistodetermineasuccessor
auditorsresponsibilitywhenfinancialstatements
auditedbyapredecessorauditorarefoundto
requiresubstantialrevi
sions.Answer(d)iscorrectbecausewhena
successorauditorbecomesawareof
informationthatindicatesthatfinancial
statementsreportedonbythepredecessormay
requirerevision,thesuccessorshouldrequest
thattheclientarrangeameetingamongthe
threepartiestodiscussandattempttoresolve
thematter.Answer(a)isincorrectbecausethe
successorisnotrequiredtonotifytheaudit
committeeandstockholders.Answer(b)is
incorrectbecausetheclientshouldfirst
communicatewiththepredecessorbefore
revisingthefinancialstatements.Answer(c)is
incorrectbecauseameetingofthethreeparties
isarrangedbytheclientandbecausethe
situationmayormaynothaveanythingtodo
withtheintegrityofmanagement.
94.(c)Therequirementistodetermine
whetherasuccessorauditorshouldrequesta
newclienttoauthorizethepredecessorauditor
toallowareviewofthepredecessors
engagementletter,workingpapers,orboth.
An
swer(c)iscorrectbecauseAU315statesthat
itisadvisablethatasuccessorauditorrequest
tobeallowedtoreviewthepredecessors
workingpapers.
C.2.PerformAnalyticalProcedures
95. (b)Therequirementistoidentify
theauditprocedurethatanauditor
willmostlikelyperformin
planningafinancialstatement
audit.Answer(b)iscorrect
becauseAU329requiresthatan
auditorperformanalyticalproce
duressuchascomparingthe
financialstatementstoanticipated
resultsduringtheplanningstageof
anaudit.Answers(a),(c),and(d)
areallincorrectbecausethese
procedureswillalloccur
subsequenttoplanning.
96. (c)Therequirementistodeterminetheproper
focusofanalyticalproceduresusedinplanningan
audit.Answer(c)iscorrectbecauseanalytical
proceduresusedinplanningshouldfocuson(1)
enhancingtheauditorsunderstandingofthe
clientsbusinessandthetransactionsandevents
thathaveoccurredsincethelastauditdate,and(2)
identifyingareasthatmayrepresentspecificrisks
relevanttotheaudit.Answer(a)isincorrect
becausewhileanalyticalproceduresperformedas
substantivetestsmayaffectthescopeofother
substantivetestsandoftestsofcontrols,analytical
proceduresusedinplanninggenerallydonot.
Answer(b)isincorrectbecausethegeneralnature
ofanalyticalproceduresusedinplanningprovide
onlyverylimitedassurancethatpotential
misstatementswillbeidentified;analytical
proceduresusedassubstantivetestsprovidea
levelofassurancethatpotentialmisstatements
willbeidentified.Answer(d)isincorrectbecause
analyticalproceduresperformedatthereview
stageofauditsmoredirectlyrelatetoassessingthe
adequacyoftheavailableevidence.
97. (a)Therequirementistoidentifythe
objectiveofperforminganalytical
proceduresinplanninganaudit.An
swer(a)iscorrectbecauseAU329
statesthattheobjectiveofsuch
proceduresduringplanningistoidentify
suchthingsastheexistenceofunusual
transactionsandevents,amounts,ratios
andtrendsthatmightindicatematters
thathavefinancialstatementandaudit
planningramifications.An
swers(b),(c),and(d)areallincorrect
becausewhileanalyticalproceduresmay
leadtothediscoveryofillegalacts,related
partytransactions,andunauthorized
transactions,thisisnottheprimaryobjective.
98. (c) The requirement is to identify the
type of nonfinancial information an
auditorwouldmostlikelyconsiderin
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
57
101. (c)Therequirementistoidentifythenextstep
inassessingtherisksofmaterialmisstatement
performinganalyticalproceduresduringthe
afterauditorsidentifyrisks,relateriskstowhat
planningphaseofanaudit.Answer(c)is
couldgowrong,andconsiderthemagnitudeof
correctbecausethesquarefootageofselling
risks.Answer(c)iscorrectbecausethe
spacemaybeusedinconsideringtheoverall
professionalstandardssuggestthatauditors
reasonablenessofsales.Answer(a)isincorrect
shouldthenconsiderthelikelihoodthatrisks
becausewhiletheturnoverofpersonnelinthe
involvedcouldresultinmaterialmisstatements.
accountingdepartmentmayprovideameasure
Answer(a)isincorrectbecausetheassessment
ofriskrelatingtotheaccountingfunction,itis
isnotlimitedtoillegalacts.Answer(b)is
notordinarilyusedinperforminganalytical
incorrectbecausethecomplexityof
procedures.Similarly,answer(b)isincorrect
transactionsisnotnexttobeconsidered.
becausewhiletheobjectivityofaudit
Answer(d)isincorrectbecausedetermining
committeemembersisanimportantconsid
materialitylevelsoccurspriortothisstageof
eration,itisnotordinarilyusedinperforming
theaudit.
analyticalprocedures.Answer(d)isalso
incorrectbecausemanagementsplansto
102. (b)Therequirementistoidentify
repurchasestockisnotdirectlyrelatedto
whethersubstantivetestsofdetails
analyticalprocedures.SeeAU329for
and/orriskassessmentprocedures
informationonanalyticalprocedures.
areconsideredfurtheraudit
proceduresthatmaybedesigned
C.4.SupervisionRequirements
afterassessingtherisksofmaterial
misstatement.Furtheraudit
99. (b)Therequirementistoidentifythe
proceduresarecomposedof
informationthatismostlikelytobe
substantiveprocedures
communicatedbyasupervisortostaff
assistants.Answer(b)iscorrect
becausestaffassistantsmustbe
awareofhowtheirproceduresshould
beevaluatedinordertoperformthese
procedureseffectively.Answer(a)is
incorrectbecausesomeimmaterial
fraudmaybereportedtotheclients
auditcommittee.Answer(c)is
incorrectbecausetheemphasisinan
auditmustbeonperformingthe
auditeffectivelyandnotmerelyon
adheringtotimebudgets.Answer(d)
isincorrectbecausedecisions
regardingtransferringdocuments
fromthecurrentfiletothepermanent
filearegenerallyoflessimportance
thantheproceduresuggestedby
answer(b).
100. (b)Therequirementistodeterminewhythe
workofeachassistantshouldbereviewed.
Answer(b)iscorrectbecauseAU311suggests
thattheworkperformedbyeachassistant
shouldbereviewedtodeterminewhetheritwas
adequatelyperformedandtoevaluatewhether
theresultsareconsistentwiththeconclusionsto
bepresentedintheauditorsreport.Answer(a)
isincorrectbecauseCPAfirms,notindividual
auditorswithinthefirms,havesystemsof
qualitycontrol.Answer(c)isincorrectbecause
theprofessionalstandardsdonotingeneral
approvespecificauditprocedures.Answer(d)
isincorrectbecausewhiledeterminingthatthe
audithasbeenperformedbypersonshaving
adequatetechnicaltrainingandproficiencyas
auditorsisimportant,itshouldbeaddressed
priortothecommencementoffieldwork.
D. Assess the Risks of Material
Misstatement and Design
FurtherAuditProcedures
(testsofdetailsandanalyticalprocedures)and
testsofcontrols.Answer(b)iscorrect
becausewhilesubstantivetestsofdetailsare
furtherauditprocedures,riskassessmentpro
ceduresarenot.Answer(a)isincorrect
becauseriskassessmentproceduresarenot
furtherauditprocedures.Answer(c)is
incorrectbecausesubstantivetestsofdetails
arefurtherauditproceduresandbecauserisk
assessmentproceduresarenot.Answer(d)is
incorrectbecausesubstantivetestsofdetails
arefurtherauditprocedures.
103. (b)Therequirementistoidentifythe
procedurethatisleastlikelytobe
consideredariskassessment
procedure.Answer(b)iscorrect
becauseconfirmationisasubstantive
test,ratherthanariskassessment
procedure.Answers(a),(b),and(c)
areallriskassessmentprocedures,as
arecertaininquiriesofothersoutside
theentity.
104. (d)Answer(d)iscorrectbecause
significantrisksofteninvolve
accountingestimatesorcomplex
accountingthatinvolvessignificant
judgments.Answer(a)isincorrect
becauseroutine,highvolume
transactionstypicallyhavelower
risk.Answer(b)isincorrectbecause
significantrisksdorequirespecial
auditattention.Answer(c)is
incorrectbecausesignificantrisks
involveitemswithhighlevelsof
inherentrisk.
E. QualityControl
105.(b)Therequirementistodeterminethe
propermethodforhandlingadifferenceof
opinionbetweenauditorsconcerning
interpretationoftheresultsofanauditing
procedure.Answer(b)iscorrectbecausethe
qualitycontrolstandardsrequire
documentationoftheconsiderationsinvolved
intheresolutionofdifferencesofopinion.An
swer(a)isincorrectbecausetheAICPAdoes
not,ingeneral,ruleondisagreementsofthis
nature.Answer(c)isincorrectbecausethe
disagreementrelatestoanauditingprocedure
andthereforeinmostsuchcircumstancesthe
entitysmanagementoritsauditcommittee
willhavenoparticularexpertise.Answer(d)is
incorrectbecausethedisagreementneednot
necessarilybereportedtoapeerreview
monitoringteam.
E.4.ProspectiveFinancialStatements
106.(d)Therequirementistoidentifywhatis
includedintheexaminationofafinancial
forecast.Answer(d)iscorrectbecausean
examinationofaforecastincludesan
evaluationofitspreparationandthesupport
underlyingmanagementsassumptions.As
discussedinAT301,anexaminationalso
includesevaluatingtherepresentationofthe
prospectivefinancialstatementsforconformity
withAICPApresentationguidelinesandthe
issuanceofanexaminationreport.Answer(a)
isincorrectbecausetheserviceneednot
includethecompilingorassemblingofthe
financialforecast.Answer(b)isincorrect
becausedistributionoffinancialforecasts
neednotbelimited.Answer(c)isincorrect
becausetheCPAassumesnoresponsibilityto
updatemanagementonkeyevents.SeeAT
301forinformationonprospectivefinancial
information.
E.5.QualityControl
107.(a)Therequirementistodeterminethe
factorsthataffectthenatureandextentofaCPA
firmsqualitycontrolpoliciesandprocedures.
Answer(a)iscorrectbecausethenatureand
extentofafirmsqualitycontrolpoliciesand
proceduresdependonanumberoffactors,
includingitssize,
58
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
professionalstandards.
thedegreeofoperatingautonomyallowedto
itspersonnelandpracticeoffices,thenature
of its practice, its organization, and
appropriatecostbenefitconsiderations.
108. (d)Therequirementistoidentifythe
mannersinwhichaCPAfirmmay
communicateitsqualitycontrol
policiesandprocedurestoits
personnel.Answer(d)iscorrect
becausetherequirementsrelatingto
qualitycontrolstandard
documentationstatethateitherorally
orwrittenareacceptable.Answers
(a),(b)and(c)allincludeoneor
moreinappropriatenoreplies.
109. (c)Therequirementistoidentifythe
replythatisnotoneoftheelements
ofqualitycontrol.Answer(c)
iscorrectbecausethereisnoquality
controlelementoninternalcontrol.
Acceptanceofclientrelationships
andspecificengagements(a),human
resources(b),andmonitoring(d)are
allelementsofqualitycontrol.In
addition,thefollowingalsoare
elementsofqualitycontrol:
leadershipresponsibilitiesfor
engagementperformance,quality
withinthefirm,andrelevantethical
requirements.
110. (d)Therequirementistodeterminethetypesof
servicestowhichStatementsonQuality
ControlStandardsapply.Answer(d)iscorrect
becausethestandardsexplicitlylimit
applicationtoauditingandaccountingand
reviewservices.Althoughthequalitycontrol
standardsmaybeappliedtoothersegmentsofa
firmspractice(e.g.,managementadvisory
servicesandtax),thestandardsdonotrequire
it.
111. (a)TherequirementistodeterminehowaCPA
firmobtainsreasonableassuranceofproviding
professionalservicesthatconformwith
professionalstandards.Answer(a)iscorrect
becauseasystemofqualitycontrolisdesigned
toprovideaCPAfirmwithreasonable
assuranceofmeetingitsresponsibilityto
provideprofessionalservicesthatconformwith
professionalstandards.Answer(b)isincorrect
becauseapeerreviewprovidesinformationon
whetheraCPAfirmisfollowinganappropriate
systemofqualitycontrol.Answer(c)is
incorrectbecauseitislesscompletethanan
swer(a)sincecontinuingprofessional
educationhelpsachievethespecificquality
controlelementofprofessionaldevelopment.
Answer(d)isincorrectbecausecomplyingwith
generallyacceptedreportingstandardsisonly
onepartofthebasicobjectiveofproviding
professionalservicesthatconformwith
E.6.PublicCompanyAccounting
OversightBoard
Requirements
112.(b)Therequirementistoidentifythe
correctstatementconcerningPCAOB
guidancethatusesthetermshould.Answer
(a)iscorrectbecausethetermshouldmeans
thattheauditormustcomplywiththe
requirementsunlessheorshecandemonstrate
thatalternativeactionsweresufficientto
achievetheobjectivesofthestandards.
Answer(a)isincorrectbecausetermssuchas
must,shall,andisrequiredtoareused
toindicatethattheauditormustfulfillthe
responsibilities.Answer(c)isincorrect
becausetermssuchasmay,might,and
couldareusedwhentheauditorshould
considerperformingtheauditprocedure.
Answer(d)isincorrectbecausenoparticular
termsareusedforthesituationinwhichthe
auditorhascompletediscretionwhetherto
performtheprocedure.
113.(c)Therequirementistodeterminetheset
ofstandardsthatthePCAOBdoesnothave
authoritytoestablish.Answer(c)iscorrect
becausetheFASBestablishesaccounting
standardsforbothpublicandnonpublic
companies.Answer(a)isincorrectbecausethe
PCAOBhasauthoritytoissueauditing
standards.Answer(b)isincorrectbecausethe
PCAOBhastheauthoritytoissuequality
controlstandards.Answer(d)isincorrect
becausethePCAOBhastheauthoritytoissue
independencestandards.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
59
SOLUTIONTOSIMULATIONS
TaskBasedSimulation1
AuditRisk
Application
Authoritative
Literature
Help
Factor
1. Branchmanagementauthority
IncreasedauditriskDecreasedauditrisk
2. Governmentregulation
3. Companyprofitability
4. Demandforproduct
5. Interestrates
6. Availabilityofmortgagefunds
7. Involvementofprincipalshareholderin
management
8. Branchmanagercompensation
9. Internalauditreportingrelationship
10. Accountingdepartmentturnover
11. Continuingauditrelationship
12. Internalcontrolsoveraccountingestimates
13. Responsetoproposedaccountingadjustments
14. Newunprofitablebranch
15. Newcomputersystem
TaskBasedSimulation2
RiskofMaterial
Misstatement
Authoritative
Literature
Help
Risk
1. Computerfraudrisk
2. Riskrelatedtomanagementoverrideofinternalcontrol
3. Fraudbybranchmanagement
4. Fraudbyaccountingpersonnel
5. Misstatementofaccountingestimates
6. Fraudbyloanprocessingclerks
7. Fraudbyinternalauditors
8. Theriskoffraudulentmisstatementofrevenues
TaskBasedSimulation3
Research
Topics
1.
2.
T
r
P
T
h
Authoritative
Literature
Help
Highriskitem
Fraudriskfactor
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
60
Transactions
4. Comparingaclientsunauditedresultsfortheyearwithlastyearsauditedresults.
(A)(B)(C)(D)(E)(F)(G)(H)(I)
5. Auditingandreportingguidanceonthepossibleneedtoreauditpreviousyear
resultsduetothedisbandingofthefirmthatperformedlastyearsaudit.
6. Requirementsrelatingtoidentifyingviolationsofoccupationalsafetyandhealth
regulations.
7. Auditreportconsiderationswhenauditofasubsidiaryoftheclientwillbe
performedbyWilliams&Co.,CPAs.
8. Theneedtobrainstormamongauditteammembersabouthowaccountscould
beintentionallymisstated.
9. Detailsonconsideringdesigneffectivenessofcontrols.
10. Theimportanceofconsideringthepossibilityofoverstatedrevenues(forexample,
throughprematurerevenuerecognition).
TaskBasedSimulation4
RiskAnalysis
Authoritative
Literature
Help
(A
)
(B
)
(C
)
(D
)
1.
Ofthefollowing,whichislikelytobeoneofDietWebsmajorrisksofdoingbusinesson
theInternetinthefuture?
2.
WhichofthefollowingislikelytobethemostsignificantbusinessriskforDietWeb?
3.
WhichofthefollowingismostaccurateconcerningDietWebsauditcommittee?
4.
Whichofthefollowingindicatesanincreasedriskofmisstatementduetofraud?
5.
WhichofthefollowingisthemostsignificantriskfacingDietWebthatmightcauseittonotbe
abletocontinueincreasingsales?
Explanationofsolutions
1.
(A)TherequirementistoidentifyDietWebsmajorlistedriskofdoingbusinessonthe
Internet.Answer(A)iscorrectbecauseDietWebmustcarefullymaintaintheprivacyof
theircustomersinformationbothduetolawandduetoDietWebsassuranceprovidedto
itscustomers.Answer(B)isincorrectbecausetherearenomajorFederalCommunications
CommissionInternetusefees.Answer(C)isincorrectbecausethecaseindicatesno
particularprobleminproviding24/7/365support.Answer(D)isincorrectbecausethe
InternetisabletoreachcustomersbeyondtheUnitedStates.
2.
(C)TherequirementistoidentifythemostsignificantbusinessrisklistedforDietWeb.
Answer(C)iscorrectbecausebarrierstoentranceontheInternetareordinarilynothigh.
Anotherorganizationmightdevelopsimilar(ormoreaccepted)software,and/orcharge
lowerpricesthanthosechargedbyDietWeb.Answer(A)isincorrectbecauseinternal
controllimitationsneednotnecessarilybeamajorproblem,andbecauseinternalcontrol
relatestocontrolriskmoredirectlythantothecompanysbusinessrisk.Answer(B)is
incorrectbecausewhileInternetinstabilitymaycausedifficulties,fewwouldconsideritas
significantaproblemasnewcompetitors.Answer(D)isincorrectbecausedetermining
appropriateyearendcutoffsisnotlikelytocreatemajordifficulties.
3.
4.
(C)TherequirementistoidentifythemostaccuratestatementconcerningDietWebsaudit
committee.Answer(C)iscorrectbecausetheauditcommitteehasnomemberswhoare
independentofmanagement.Answer(A)isincorrectbecausetheauditcommitteehasno
memberswhoareindependentofmanagement.Answer(A)isincorrectbecausethe
companyfoundersarenotindependent.Answer(B)isincorrectbecauseMr.Readings
chairmanshipoftheauditcommitteeislikelytoresultinaweak,notastrongaudit
committee.Answer(D)isincorrectbecausethesizeoftheboardofdirectorsvirtually
alwaysexceedsthatoftheauditcommitteeisnotequaltoorlessthaninsize.
(A)Therequirementistoidentifyafactorthatindicatesanincreasedriskofmisstatementduetofraud.
Answer(A)iscorrectbecausethesimulationprovidesnoexplanationofthenatureofthedisagreement
thatledtoMr.Williamsonsresignationfromanapparentlyverydesirablejob.Answer(B)isincorrect
becausemanysmallcompaniesaredominatedbycompanyfoundersandthosecompaniesdonot
generallymisstateearningsduetofraud.Answer(C)isincorrectbecausetheissuanceofdebtneednot
indicatefraud.Answer(D)isincorrectbecausecompetitionitselfneednotleadtoanincreasedriskof
misstatementduetofraud.
5.
(B)TherequirementistoidentifythemostsignificantriskfacingDietWebthatmight
causeitnottobeabletocontinueincreasingsales.Answer(B)iscorrectbecausethe
industryinformationmakesclearthatthemarketchangesrapidlyonly
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
companiesthatcanrespondinatimelybasisarelikelytobeabletomaintainandimprovesales.
Answers(A)and(C)areincorrectbecausethereisnoindicationthattheUnitedStateswillfacea
decreasingmarketfordietaryproductsorthatthepopulationisdecreasing.Answer(D)is
incorrectbecauseatthispointthereisnoindicationofobsolescenceoftheInternet.
T
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2.
4.
W
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W
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3.
61
5.
1.
(C)Therequirementistoidentifyalikelymisstatementinthefinancialstatements.Answer
(C)iscorrectbecausecommonstockissuedshouldbetreatedunderfinancingratherthan
operations.Answer(A)isincorrectbecauseanincreaseincashmaywelloccureven
duringayearinwhichthecompanyencountersaloss.Answer(B)isincorrectbecausethere
isnoindicationthattheimpairmentexpenseisinappropriate.Answer(D)isincorrect
becausepreviousyearspatternofincomeandlossesmaycreateasituationinwhichanet
incometaxbenefitoccurs.
2.
(A)Therequirementistoidentify,ofthebalancesheetchangeslisted,themostunexpected
one.Answer(A)isunexpectedinthatprepaidadvertisingexpensesdecreasedbymorethan
ninetypercentatatimewhenthecompanyincreaseditssalesandmarketingexpensesso
significantly.Answer(B)isincorrectbecausetherelativelysmallincreaseinaccounts
payablemaybeexpectedgiventheincreaseinrevenues.Answer(C)isincorrectbecauseone
wouldexpectsuchanincreaseindeferredrevenuesasrevenuesincrease.Answer(D)is
incorrectsincethecompanysimplyissuedmorestockasindicatedinthecompanyprofile.
3.
(A)Therequirementistoidentifythefactorthatmightleadtheauditorstoquestion
whetherDietWebhastheabilitytocontinueasagoingconcern.Answer(A)iscorrect
becausethecurrentnetlossmayraiseaquestionastofutureprofitability.Answer(B)is
incorrectbecausetherewasanincreaseincash,notadecrease.Answer(C)isincorrect
becausefixedassetsdecreasedratherthanincreasedduring20X8.Answer(D)isincorrect
becauseMr.ReadingsservingasCEOindicatesnoparticularproblem.
4.
(B)Therequirementistoidentifyanincorrectclassificationinthefinancialstatements.
Answer(B)iscorrectbecauseaccruedliabilitiesareingeneralcurrent,notnoncurrent,
liabilities.Answer(A)isincorrectbecauseprepaidexpensesareordinarilyassets.Answer
(C)isincorrectbecauseonewouldexpectthedeferredtaxliabilitytohaveapositive
balance.AnswerDisincorrectbecausetheretainedearningsnegativebalancemaybe
explainedbyearlyyearlosses.
(A)Therequirementistoidentifythemostunexpectedchange.Answer(A)ismostunexpectedbecause
theexpandedscaleofoperationswouldleadonetoexpectanincreaseinfixedassets,notadecrease.
Answer(B)isincorrectbecausesmallchangesinprepaidexpenseandothercurrentassetsareexpected.
Answer(C)isincorrectbecauseitisnotsurprisingthatcashmayincreasewhenthereisanetloss
particularlyinayearwhencommonstockhasbeenissued.Answer(C)isincorrectbecauseanincrease
inaccruedliabilitiesisconsistentwithanincreaseinthescaleofoperationsasindicatedbyalarge
increaseinsales.
TaskBasedSimulation6
RiskofMaterial
MisstatementAnalysis
Authoritative
Literature
Help
AU110,312,and316allrequirethatauditorsconsiderfactorsinfluencingtheriskofmaterial
misstatementandthattheriskofmaterialmisstatementbeconsideredduringtheplanningphaseof
anauditengagement.
1.
(D)SinceTWDreturnedtoprofitableoperation,itshealthierfinancialconditionleadstoadecreasein
theriskofmaterialmisstatement.
2.
(I)Theriskofmaterialmisstatementincreaseswhenmanagementisdominatedbyasingle
person.SinceMeadcontrolstheBoardofDirectors,isamajoritystockholder,andisthe
CEO,itwouldappearthatMeaddominatesmanagement.
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
62
3.
(I)Theriskofmaterialmisstatementincreaseswhentheinternalauditorreportstotopmanagementratherthantothe
auditcommitteebecauseitislesslikelythattheinternalauditorwillbeabletoobjectivelyperformthefunction.
4.
(I)Theriskofmaterialmisstatementincreaseswhenthekeymanagementpositions(particularlysenioraccounting
personnel)encounterturnover.
5.
(D)TheloanofficerscontinualmonitoringofTWDdecreasestheriskofmaterialmisstatement.
6.
(N)Timingofpayrollcycleswouldnormallyhavenoimpactontheriskofmaterialmisstatement.
7.
8.
(I)Astrongfinancialpresenceorabilitytodominateacertainindustrysectorthatallowsacompanytodictate
termsorconditionstosuppliersorcustomersmayresultininappropriateornonarmslengthtransactions.
(I)Achangetogenerallyacceptedaccountingprincipleswillincreasetheriskofmaterialmisstatementbecausethechangein
basisrequiresmanagementtoprepareanumberofentriesthathavenotbeenmadeinthepast;theseentriesmaybemade
improperly.Also,difficultiesindeterminingbeginningaccrualbasisbalancesincreasestheriskofmisstatement.
9.
(I)ThesaleofonehalfofthecompanyscontrollinginterestinUnitedEquipmentLeasingisanentrythatisout
oftheordinarycourseofbusiness,andaccordingly,increasestheriskofmaterialmisstatement.
10. (D)Litigationresultsincontentiousanddifficultaccountingvaluationissuesbecauseanaccountantmustattempt
todeterminethelikelihoodoflossandtheamount.
11. (I)Theriskofmaterialmisstatementincreaseswhensignificantrelatedpartytransactionsoccurandmanagement
hasanaggressiveattitudetowardsreportingofthetransactions.
12. (I)Theriskofmaterialmisstatementincreasesinsituationswherethereareunusualanddifficultaccountingissuespresent.It
wouldappearthatthebartertransactionwithabelowmarketpurchasewouldbeconsideredanunusualtransaction.
13. (N)Theamountofinsurancecoveragewouldhavelittleimpactontheriskofmaterialmisstatement.
14. (I)Theriskofmaterialmisstatementincreasesasitappearsthatmanagementhastakenanaggressiveattitude
towardreportingthistransaction.Inaddition,thisappearstobeanunusualanddifficultaccountingissueinvolving
revenuerecognition.
15. (I)Experiencehasshownthatanumberofentitieshaveintentionallymisstatedreportedfinancialconditionand
operatingresultsinsituationsinwhichapublic(orprivate)placementofsecuritiesisplanned.Accordingly,aninitial
publicofferingofstockincreasestheriskofmaterialmisstatement.
TaskBasedSimulation7
I
R
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1.
W
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2. W
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3. W
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E
1.
(C)TherequirementistoidentifythefactorthatismostlikelytoincreaseToastcosinherentrisk.Answer(C)iscorrectbecause
Toastcoreliessignificantlyuponthetoaster,andsinceobsolescenceofthatproductcouldcauseverymajordifficultiesforthe
company.Answer(A)isincorrectbecausethemanufacturingcontinuestobeinAsiaandthereisnoindicationofarelated
problem.Answer(B)isincorrectbecausethegrowthof3%,whilehigh,doesnotincreaseinherentrisk.Answer(D)isincorrect
becauseoverstatedaccountsreceivableduetointernalcontroldeficienciesrelatestocontrolrisk,notinherentrisk.
2.
(B)TherequirementistodeterminetheaspectofToastcothatismostlikelytoincreasetheriskofmisstatement
arisingfromfraudulentfinancialreporting.Answer(B)iscorrectbecausethepresident,BillWilliams,feltpressureto
meettheearningspersharenumberhehadpromisedthebankduetoweaksecondandthirdquarters.Thereforethe
highearningsinthefourthquarterrepresentarisk.Answer(A)isincorrectbecausethestabilityoftheindustry
presentsnoparticularrisk.Answer(C)isincorrectbecauseToastcosmarketsharebyitselfdoesnotseemtoposea
riskofmisstatement.Answer(D)isincorrectbecausewhileToastcowouldcertainlybeinasaferpositionwithmore
profitableproducts,thisisnotassignificantafraudriskasisthepressuretoachievetheearningspersharetarget.
3.
(B)Therequirementistodetermineanaspectofacompanythatismostlikelytoincreasetheriskofmisstatement
arising from fraudulent financial reporting. Answer (B) is correct because the presidents investmentin Toastco
createsasituationin
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
whichlossesinvalueofthecompanywillprofoundlyaffecthimparticularlygivenhisdesiretotakethecompanypublic.
Answer(A)isincorrectbecausesellingmorethanonetypeofproductmayormaynotaffecttheriskofmisstatement.An
swer(C)isincorrectbecauseitisdesirabletohavetheauditcommitteecomposedentirelyofindependentdirectors.Answer
(D)isincorrectbecausethefactthatthisisacontinuingengagementhasnodirecttietotheriskofmisstatement.
RatioAnalysis
(A)(B)(C)(D)(E)(F)(G)
1. Anauditfindingmostconsistentwiththechangeinthegrossmarginpercentage
2. Anauditfindingmostconsistentwiththechangeinthecurrentratio
Explanationofsolutions
1.
(A)Therequirementistoidentifyanauditfindingmostconsistentwithadecreaseinthegrossmarginpercentage
grossmargin/sales.Answer(A)iscorrectbecausetheinabilitytopassonincreasesincostswilldecreasethegross
marginbecausecostofgoodssoldasapercentageofsaleswillincrease.
2.
(G)Therequirementistoidentifyanauditfindingthatisconsistentwithadecreaseinthecurrentratiocurrent
assets/currentliabilities.Answer(G)iscorrectbecausethelongtermdebtbecomingcurrentincreasesthe
denominatorofthecurrentratio,whichdecreasestheratio.
(H) (I) (J) (K) (L)(M)
3. AnauditfindingconsistentwiththechangeininventoryturnoverforToastco
4. Anauditfindingconsistentwiththechangeinthereturnonequity
Explanationofsolutions
3.
(K)Therequirementistoidentifythefindingthatisconsistentwithanincreaseintheinventoryturnoverratio
costofgoodssold/inventory.Answer(D)iscorrectbecausealargerpercentageofsalesinthelastmonthislikelyto
resultinalowerendinginventory,thusincreasingtheinventoryturnoverratiosincethedenominatorofthefraction
becomessmaller.
4.
(J)Therequirementistoidentifythereplythatisconsistentwithadecreaseinthereturnonequityrationet
income/shareholdersequity.Answer(C)iscorrectbecauseretentionofprofitsincreasestheshareholdersequity,
therebydecreasingtheratio.
TaskBasedSimulation8
ObservedRatio
Changes
1.
2.
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3.
A
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4.
L
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Authoritative
Literature
Help
63
6.Grossmarginpercentagewasunchangedfromthe
prioryearalthoughgrossmarginincreasedfrom
theprioryear.(Selectoneexplanation)
Explanationofsolutions
1.(A,B,D)Therequirementistoidentifythreeexplanationsforanincreaseintheinventoryturnoverwhencomparedto
theprioryear.Theinventoryturnoveriscalculatedbydividingthecostofgoodssoldbytheinventory.Anincreasemayoccur
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
64
eitherthrough(1)anoverstatementofthecostofgoodssold(thenumerator),(2)anunderstatementofinventory(thedenomi
nator),or(3)acombinationofchanges.Answer(A)iscorrectbecausetherecordingoftheconsignmentshipmentasasalewill
overstatecostofgoodssoldandunderstatetheendinginventory.Answer(B)iscorrectbecausenotrecordingthecreditmemos
willresultinunderstatementofinventory.Answer(D)iscorrectbecausetheunderstatementofpurchasesofinventorywill
understatetheendinginventory.
Answer(C)isincorrectbecauseoverstatingtheyearendpurchaseswillresultinoverstatementofinventory,andthereby
decreasetheinventoryturnover.Answers(E)through(J)areallincorrectbecausesuchchangesinsaleswillnotaffectthein
ventoryturnoverratio.Answers(K)through(P)areallincorrectbecausetheinterestexpense,incometaxrate,andtheshort
termborrowingdonotaffecttheinventoryturnover.Notethatthisquestionreliesuponanunstatedassumptionthattheyear
endinventoryisnotadjustedtoayearendphysicalcount.
2.
(A,B,E)Therequirementistoidentifythreeexplanationsforadecreaseintheaccountsreceivableturnoverwhencom
paredtotheprioryear.Theaccountsreceivableturnoveriscalculatedbydividingsalesbyaccountsreceivable.Adecrease
mayoccurthrough(1)anunderstatementofsales(thenumerator),(2)anoverstatementofaccountsreceivable(the
denominator),or(3)acombinationofmisstatementsofsalesandaccountsreceivablethatdecreasetheratio.Answer(A)
iscorrectbecauserecordingtheconsignmentassalesoverstatesbothsalesandaccountsreceivablebyanidenticalamount,
thusdecreasingtheratio;thedecreaseisduetotheentrydebitingaccountsreceivableandcreditingsalesforthesame
amount.Answer(B)iscorrectbecausenotrecordingthecreditmemooverstatesbothsalesandaccountsreceivablebyan
identicalamount,thusdecreasingtheratio;thisidenticalamountofdecreaseisduetothelackofadebittosalesreturns
andallowancesandacredittoaccountsreceivable.Notethatanswers(A)and(B)arecorrectinanysituationinwhichthe
ratioisgreaterthan1.0;whentheratioislessthan1.0theyresultinanincreaseintheratio.Answer(E)iscorrectbecause
whilethesalesfortheyearremainattheexpectedlevel,accountsreceivableatyearendwillbeatahigherthanaverage
levelduetotheyearendsales.
Answers(C)and(D)areincorrectbecausethelevelofinventorydoesnotaffecttheratio.Answers(F)and(G)areincor
rectbecausealarger,notasmallerorthesame,percentageofsalesnearyearenddecreasestheratio.Answers(H),(I)and(J)
areincorrectbecauseonewouldexpectaccountsreceivabletoincreaseatthesamerateastheincreaseinsales.Answers(K)
through(P)areallincorrectbecauseinterestexpense,incometaxrate,andtheshorttermborrowingdonotaffecttheaccounts
receivableturnover.
3.
(A,B,E)Therequirementistoidentifythreeexplanationsforanincreaseintheallowancefordoubtfulaccounts,but
adecreaseintheallowancefordoubtfulaccountsasapercentageofaccountsreceivable.Theallowancefordoubtful
accountsasapercentageofaccountsreceivableiscalculatedbydividingtheallowancefordoubtfulaccountsby
accountsreceivable.Thepercentagemaydecreasedueto(1)adecreaseintheallowancefordoubtfulaccounts,(2)an
increaseintheaccountsreceivable,or(3)acombinationofmisstatementsthatdecreasetheratio;here,however,we
aretoldthatreason(1),adecreaseintheallowance,hasnotoccurred.Answer(A)iscorrectbecauserecordingthe
consignmentasasaleresultsinanincreaseinaccountsreceivablewhichdecreasestheratio.Answer(B)iscorrect
becausenotrecordingthecreditmemosoverstatesaccountsreceivable,therebydecreasingtheratio.Answer(E)is
correctbecausethelargerpercentageofsalesoccurringduringthelastmonthoftheyearresultsinaccountsreceivable
atyearendthatwillbeatahigherthanaveragelevelduetotheyearendsales.
Answers(C)and(D)areincorrectbecausethelevelofinventorydoesnotaffecttheratio.Answers(F)and(G)areincor
rectbecausealarger,notasmallerorthesame,percentageofsalesnearyearenddecreasestheratio.Answers(H),(I),and(J)
areincorrectbecauseonewouldexpectaccountsreceivableandtheallowancefordoubtfulaccountstoincreaseatapproxi
matelythesamerateastheincreaseinsales.Answers(K)through(P)areallincorrectbecauseinterestexpense,incometax
rate,andtheshorttermborrowingdonotaffecttheaccountsreceivableturnover.
4. (P)Therequirementistoidentifyareasonwhylongtermdebtincreased,butinterestexpenseincreasedalarger
thanproportionateamountthanlongtermdebt.Answer(P)iscorrectbecausethehigherinterestratesonlongterm
debtwillresultinhigherinterestexpense.Answers(A)through(M)areallincorrectbecausetheyrelateneitherto
longtermdebtnorinterestexpense.Answers(N)and(O)areincorrectbecauserefinancingatthesameoralower
interestratewillresultinsmallerthanproportionateamountsofinterestexpense.
5.
(L,P)Therequirementistoidentifytworeasonswhyoperatingincomemightincrease,yetthecompanywouldbe
lessprofitable.Sinceoperatingincomeincreasedandnetincomedecreased,theexplanationmustbeitemsthatare
listedontheincomestatementbetweenoperatingincomeandnetincomeinterestexpenseandfederalincometaxes.
Thenetofthesetwoexpensesmusthaveincreasedtoresultinasituationinwhichtheentitywaslessprofitable.
Answer(L)iscorrectbecauseanincreaseintheeffectiveincometaxratecoulddecreasetheprofitwhencomparedto
theprioryear.Answer(P)iscorrectbecausehigherinterestratesdecreaseprofits.Answers(A)through(J)areall
incorrectbecausetheypertaintodetailsofoperatingincome.Answers(K)and(M)areincorrectbecauseadecrease
ininterestexpenseortheincometaxratewouldincreasenetincome.Answer(N)isincorrectbecauserefinancingat
thesameratewillnotaffectnetincome.Answer(O)isincorrectbecauserefinancingatalowerinterestratewill
increaseprofits.
6.
(H)Therequirementistoidentifyonereasonwhythegrossmarginpercentagemayremainunchanged,despitean
increase in gross margin from the prior year. Answer (H) is correct because when sales increase at the same
percentageascostofgoodssold,thegrossmarginpercentageremainsunchanged,andyettheincreasedsaleswill
resultinanincreaseinthegrossmargin.
Answers(A)through(D)areallincorrectbecausetheywillresultinachangeinthegrossmarginpercentage.Answers(E),(F),
and(G)areallincorrectbecausenoincreaseinsalesisindicatedandnoinformationonthegrossmarginisprovided.Answers
(I)and(J)areincorrectbecausetheysuggestadecreaseandanincreaseinthegrossmargin,respectively.Answers(K)through
(P)areallincorrectbecauseinterestexpense,incometaxrate,anddebtdonotaffectgrossmargin.
MODULE2 ENGAGEMENTPLANNINGANDASSESSINGRISKS
65
TaskBasedSimulation9
Assertionsand
AuditProcedures
Authoritative
Literature
Assertion
1. Completeness
Help
(A)(B)(C)(D)(E)(F)
2. Cutoff
3. Existenceandoccurrence
4. Presentationanddisclosure
5. Rightsandobligations
6. Valuation
Auditprocedures
1. Prepareaflowchartofinternalcontroloversales
2. Calculatetheratioofbaddebtexpensetocreditsales.
3. Determinewhetherdisbursementsareproperlyapproved.
4. Confirmaccountsreceivable.
5. Comparecurrentfinancialinformationwithcomparablepriorperiods.
TaskBasedSimulation10
AuditRiskand
ItsComponentsAuthoritative
Literature
Help
1.
(No)Theriskofmaterialmisstatementiscomposedofinherentriskanddetectionrisk.
2.
(Yes)
3.
(No)Adecreaseincontrolrisk,absentotherchanges,resultsinadecreaseintheriskofmaterialmisstatement.
4.
(Yes)Detectionriskisafunctionoftheauditanditsprocedures.Ifthereisnoauditthereisnomeasureofdetectionrisk.
5.
(No)Thisisbackwards.Auditorsrestrictdetectionriskthroughtheperformanceofmoresubstantiveprocedures.
Auditorsassessinherentriskandcontrolrisk.
6.
(Yes)
7.
(No)Theerroristheorimmaterially.Auditriskdealswithmaterialmisstatements.
8.
(Yes)
2.
TaskBasedSimulation11
Research:
Supervision
Authoritative
Literature
1.
Help
WhichtitleoftheProfessionalStandardsaddressesthisissueandwillbehelpfulin
respondingtotheCEO?
(A)(B)(C)(D)(E)(F)(G)(H)
210
03
MODULE2ENGAGEMENTPLANNINGANDASSESSINGRISKS
66
TaskBasedSimulation12
Research:Tone
attheTop
Authoritative
Literature
Help
1. WhichtitleoftheProfessionalStandardsaddressesthisissueandwillbehelpful
inrespondingtothepartner?
2. Entertheexactsectionandparagraphswithhelpfulinformation.
TaskBasedSimulation13
EffectsonAudit
RiskComponents
S
i
1.
D
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2.
I
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E
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3.
Authoritative
Literature
Help
(A)(B)(C)(D)(E)(F)(G)(H)
10
1518
TaskBasedSimulation14
(A)(B)(C)(D)(E)(F)(G)(H)
Research
Authoritative
Literature
Help
1.
WhichtitleoftheProfessionalStandardsaddressesthisissueandwillbehelpfulin
respondingtothepartner?
2.
Entertheexactsectionandparagraphswithhelpfulinformation.
10
12
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
UNDERSTANDINGINTERNALCONTROL
ANDASSESSINGCONTROLRISK
MULTIPLECHOICEQUESTIONS(1166)
1.
a.
b.
c.
d.
2.
Whenconsideringinternalcontrol,anauditor
shouldbeawareoftheconceptofreasonable
assurance,whichrecognizesthat
a. Internalcontrolmaybeineffectivedue
to mistakes in judgment and personal
carelessness.
b. Adequatesafeguardsoveraccessto
assetsandrecordsshouldpermitan
entitytomaintainproperaccountability.
c. Establishing and maintaining internal
controlisanimportantresponsibilityof
management.
d. Thecostofanentitysinternalcontrol
shouldnotexceedthebenefitsexpected
tobederived.
3.
Propersegregationoffunctionalresponsibilities
callsforseparationofthefunctionsof
Authorization,execution,andpayment.
Authorization,recording,andcustody.
Custody,execution,andreporting.
Authorization,payment,andrecording.
a.
b.
c.
d.
4.
Anentitysongoingmonitoringactivitiesofteninclude
a. Periodicauditsbytheauditcommittee.
b. Reviewingthepurchasingfunction.
c. Theauditoftheannualfinancialstatements.
d. Controlriskassessmentinconjunction
withquarterlyreviews.
5.
a.
b.
c.
d.
6.
Whichofthefollowingmostlikelywouldnotbe
considered an inherent limitation of the
potential effectiveness of an entitys internal
control?
Incompatibleduties.
Managementoverride.
Mistakesinjudgment.
Collusionamongemployees.
Theoverallattitudeandawarenessofanentitys
boardofdirectorsconcerningtheimportanceof
internalcontrolusuallyisreflectedinits
Computerbasedcontrols.
Systemofsegregationofduties.
Controlenvironment.
Safeguardsoveraccesstoassets.
Managementphilosophyandoperatingstylemostlikely
wouldhaveasignificantinfluenceonanentityscontrol
environmentwhen
a. The internal auditor reports directly
tomanagement.
b. Managementisdominatedbyoneindividual.
c. Accuratemanagementjobdescriptions
delineatespecificduties.
d. Theauditcommitteeactivelyoverseesthefinancial
reportingprocess.
7.
Whichofthefollowingfactorsareincludedin
anentityscontrolenvironment?
a.
b.
c.
d.
Audit
committee
Yes
Yes
No
Yes
Integrityand
ethicalvalues
Yes
No
Yes
Yes
67
Organizational
No
Yes
Yes
Yes
8.
a.
b.
c.
d.
9.
10. Anauditorsuspectsthatcertainclientemployeesare
orderingmerchandiseforthemselvesovertheInternetwith
outrecordingthepurchaseorreceiptofthemerchandise.
Whenvendorsinvoicesarrive,oneoftheemployeesap
provestheinvoicesforpayment.Aftertheinvoicesarepaid,
theemployeedestroystheinvoicesandtherelatedvouchers.
Ingatheringevidenceregardingthefraud,theauditormost
likelywouldselectitemsfortestingfromthefileofall
a. Cashdisbursements.
b. Approvedvouchers.
c. Receivingreports.
d. Vendorsinvoices.
11. Whichofthefollowingproceduresmostlikely
wouldprovideanauditorwithevidenceabout
whetheranentitysinternalcontrolactivitiesare
suitablydesignedtopreventordetectmaterial
misstatements?
a. Reperforming the activities for a sample of
transactions.
b. Performing analytical procedures using
dataaggregatedatahighlevel.
c. Vouching a sample of transactions
directlyrelatedtotheactivities.
d. Observing the entitys personnel
applyingtheactivities.
12. Which statement is correct concerning the
relevance of various types of controls to a
financialaudit?
a. An auditor may ordinarily ignore a
consideration of controls when a
substantiveauditapproachistaken.
b. Controlsoverthereliabilityoffinancialreporting
areordinarilymostdirectlyrelevanttoanaudit,
butothercontrolsmayalsoberelevant.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
68
c.
d.
Controlsoversafeguardingof
assetsandliabilitiesareofprimary
importance,whilecontrolsover
thereliabilityoffinancialreporting
mayalsoberelevant.
All controls are ordinarily relevant to an
audit.
13. Inanauditoffinancialstatementsin
accordancewithgenerallyacceptedauditing
standards,anauditorisrequiredto
a. Document the auditors
understanding of the entitys
internalcontrol.
b. Searchforsignificantdeficiencies
intheoperationofinternalcontrol.
c. Perform tests of controls to
evaluate theeffectivenessof the
entitysinternalcontrol.
d. Determine whether controls are
suitably designed to prevent or
detectmaterialmisstatements.
14. Inobtaininganunderstandingofan
entitysinternalcontrolrelevanttoaudit
planning,anauditorisrequiredtoobtain
knowledgeaboutthe
a. Designofthecontrolspertainingtointernal
controlcomponents.
b. Effectiveness of controls that
havebeenimplemented.
c. Consistency with which controls
arecurrentlybeingapplied.
d. Controls related to each principal
transaction class and account
balance.
15. An auditor should obtain sufficient
knowledge of an entitys information
systemtounderstandthe
a. Safeguardsusedtolimitaccessto
computerfacilities.
b. Processusedtopreparesignificant
accountingestimates.
c. Controlsusedtoassureproper
authorizationoftransactions.
d. Controls used to detect the concealment of
fraud.
16. Whenobtaininganunderstandingofan
entitysinternalcontrol,anauditorshould
concentrateonthesubstanceofcontrols
ratherthantheirformbecause
a. The controls may be operating
effectively but may not be
documented.
b. Management may establish
appropriate controls but not
enforcecompliancewiththem.
c. The controls may be so
inappropriate that no relianceis
contemplatedbytheauditor.
d. Management may implement
controlswhosecostsexceedtheir
benefits.
c.
a.
b.
c.
d.
Riskassessmentprocedures.
Testsofcontrols.
Substantiveprocedures.
Analyticalprocedures.
23. Controlriskshouldbeassessedintermsof
a. Specificcontrols.
b. Typesofpotentialfraud.
c. Financialstatementassertions.
d. Controlenvironmentfactors.
24. Afterassessingcontrolrisk,anauditordesirestoseek
afurtherreductionintheassessedlevelofcontrolrisk.
Atthistime,theauditorwouldconsiderwhether
a. Itwouldbeefficienttoobtainan
understanding of the entitys
20. Which of the following statements
informationsystem.
regarding auditor documentation of the
b. Theentityscontrolshavebeenimplemented.
clientsinternalcontroliscorrect?
c. Theentityscontrolspertaintoany
a. Documentationmustincludeflowcharts.
financialstatementassertions.
b. Documentation must include procedural
d. Additional audit evidence
writeups.
sufficient to support a further
c. No documentation is necessary
reduction is likely to be
althoughitisdesirable.
available.
d.
21. Inobtaininganunderstandingofanentitys
internalcontrol,anauditorisrequiredtoobtain
knowledgeaboutthe
a.
b.
c.
d.
Operatingeffectiveness
ofcontrols
Yes
No
Yes
No
Design
ofcontrols
Yes
Yes
No
No
25. Assessingcontrolriskatalowlevelmost
likelywouldinvolve
a. Performing more extensive
substantive tests with larger
sample sizes than originally
planned.
b.
Reducinginherentriskformostof
the assertions relevant to
significantaccountbalances.
c.
Changingthetimingofsubstantive
testsbyomittinginterimdate
testingandperformingthetestsat
yearend.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
a.
26. Anauditorassessescontrolriskbecauseit
a. Is relevant to the auditors
understanding of the control
environment.
b. Provides assurance that the
auditors materiality levels are
appropriate.
c. Indicates to the auditor where
inherentriskmaybethegreatest.
d. Affectsthelevelofdetectionrisk
thattheauditormayaccept.
27. Whenanauditorincreasestheassessedlevel
of control risk because certain control
activitiesweredeterminedtobeineffective,
theauditorwouldmostlikelyincreasethe
a. Extentoftestsofcontrols.
b. Levelofdetectionrisk.
c. Extentoftestsofdetails.
d. Levelofinherentrisk.
28. Anauditorusestheknowledgeprovidedby
theunderstandingofinternalcontroland
theassessedleveloftheriskofmaterial
misstatementprimarilyto
a. Determine whether procedures
and records concerning the
safeguarding of assets are
reliable.
b. Ascertainwhetherthe
opportunitiestoallowanyperson
tobothperpetrateandconceal
fraudareminimized.
c. Modify the initial assessments of
inherent risk and preliminary
judgmentsaboutmaterialitylevels.
d. Determine the nature, timing,
and extent of substantive tests
for financial statement
assertions.
29. Anauditormaycompensateforaweakness
ininternalcontrolbyincreasingthe
a. Levelofdetectionrisk.
b. Extentoftestsofcontrols.
c. Preliminaryjudgmentaboutauditrisk.
d. Extentofanalyticalprocedures.
30. Which of the following statements is correct
concerninganauditorsassessmentofcontrolrisk?
a. Assessingcontrolriskmaybe
performedconcurrentlyduring
anauditwithobtaininganunder
standingoftheentitysinternal
control.
b. Evidence about the operation of
internalcontrolinpriorauditsmay
notbeconsideredduringthecur
rent years assessment of control
risk.
c. Thebasisforanauditorsconclusionsabout
theassessedlevelofcontrolriskneednotbe
69
documentedunlesscontrolriskisassessed
atthemaximumlevel.
d. Thelowertheassessedlevelof
controlrisk,thelessassurance
theevidencemustprovidethat
thecontrolproceduresare
operatingeffectively.
d.
Dualpurposeteststoevaluate
boththeriskofmonetary
misstatementandpreliminary
controlrisk.
32. Howfrequentlymustanauditortestoperating
effectivenessofcontrolsthatappeartofunctionas
theyhaveinpastyearsandonwhichtheauditor
wishestorelyinthecurrentyear?
a. Monthly.
b. Eachaudit.
c. Atleasteverysecondaudit.
d. Atleasteverythirdaudit.
33. Beforeassessingcontrolriskatalevellower
thanthemaximum,theauditorobtains
reasonableassurancethatcontrolsareinuse
andoperatingeffectively.Thisassuranceis
mostlikelyobtainedinpartby
a. Preparingflowcharts.
b. Performingsubstantivetests.
c. Analyzingtestsoftrendsandratios.
d. Inspectionofdocuments.
34. An auditor generally tests the segregation
ofdutiesrelatedtoinventoryby
a. Personalinquiryandobservation.
b. Testcountsandcutoffprocedures.
c. Analytical procedures and invoice
recomputation.
d. Documentinspectionandreconciliation.
35. The objective of tests of details of
transactions performed as tests of
controlsisto
a.
b.
Determine whether
controls have been
implemented.
Detect material misstatements in
the account balances of the
financialstatements.
Evaluate whether controls operated
effectively.
c.
d.
36. Afterobtaininganunderstandingofinternalcontrol
andassessingtheriskofmaterialmisstatement,an
auditordecidedtoperformtestsofcontrols.The
auditormostlikelydecidedthat
a. Itwouldbeefficienttoperform
tests of controls that would
resultinareductioninplanned
substantivetests.
b. Additionalevidencetosupporta
furtherreductionintheriskof
materialmisstatementisnot
available.
c. Anincreaseintheassessed
leveloftheriskofmaterial
misstatementisjustifiedfor
certainfinancialstatement
assertions.
d. Thereweremanyinternalcontrol
weaknesses that could allow
misstatements to enter the
accountingsystem.
37. In assessing control risk, an auditor
ordinarily selects from a variety of
techniques,including
a. Inquiryandanalyticalprocedures.
b. Reperformanceandobservation.
c. Comparisonandconfirmation.
d. Inspectionandverification.
38. Whichofthefollowingtypesofevidence
wouldanauditormostlikelyexamineto
determinewhethercontrolsareoperating
asdesigned?
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
70
a.
c.
Confirmations of receivables
verifyingaccountbalances.
b. Letters of representations
corroboratinginventorypricing.
Attorneys responses to the auditors
inquiries.
d. Client records documenting the
useofcomputerprograms.
Comparinganentitysuncollectible
accounts expense to actual
uncollectibleaccountsreceivable.
43. Theinternalcontrolprovisionsofthe
SarbanesOxleyActof2002applytowhich
companiesintheUnitedStates?
a.
b.
Allcompanies.
SECregistrants.
c. Allissuer(public)
companiesandnonissuer
d.
(nonpublic)companieswith
morethan$100,000,000of
networth.
Allnonissuercompanies.
44. Theframeworkmostlikelytobeusedby
management in its internal control
assessment under requirements of the
SarbanesOxleyActof2002isthe
a. COSOinternalframework.
b. COSO enterprise risk management
framework.
c. FASB 37 internal control definitional
framework.
d. AICPAinternalcontrolanalysismanager.
a. Remote.
b. Morethanremote.
45. Which of the following is correct
c. Probable.
concerning the level of assistance auditors
d. Notexplicitlyconsidered.
mayprovideinassistingmanagementwith
itsassessmentofinternalcontrol?
a. Noassistanceofanytypemaybeprovided. 51. Assumethatacompanyhasacontroldeficiency
regardingtheprocessingofcashreceipts.
b. Nolimitationsonassistanceexist.
Reconciliationofcashaccountsbyacompetent
c. Only very limited assistance may be
individualotherwiseindependentofthecashfunction
provided.
mightmakethelikelihoodofasignificant
d. As less risk is assumed by the
misstatementduetothecontroldeficiencyremote.In
auditors, a higher level of
thissituation,reconciliationmaybereferredtoaswhat
assistanceisappropriate.
typeofcontrol?
a. Compensating.
46. Whichofthefollowingneednotbeincluded
b. Preventive.
inmanagementsreportoninternalcontrol
underSection404aoftheSarbanesOxley
Actof2002?
a.
b.
Identification of the
framework for evaluating
internalcontrol.
Managementsassessmentofthe
effectivenessofinternalcontrol.
Managementsstatementof
responsibilitytoestablishand
maintaininternalcontrolthathas
nosignificantdeficiencies.
c.
d.
MODULE3 UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
c.
d.
Adjustive.
Nonroutine.
c.
d.
52. AccordingtoPublicCompanyAccounting
OversightBoardStandard5,whattypeof
transactioninvolvesestablishingaloan
lossreserve?
a. Substantivetransaction.
b. Routinetransaction.
c. Nonroutinetransaction.
d. Estimationtransaction.
53. Aprocedurethatinvolvestracingatransactionfrom
its origination through the companys information
systemsuntilitisreflectedinthecompanysfinancial
reportisreferredtoasa(n)
a. Analyticalanalysis.
b. Substantiveprocedure.
c. Testofacontrol.
d. Walkthrough.
54. Forpurposesofanauditofinternalcontrol
performed under Public Company
Accounting Oversight Board standards,
theasofdateisordinarily
a. Thefirstdayoftheyear.
b. Thelastdayofthefiscalperiod.
c. Thelastdayoftheauditorsfieldwork.
d. Theaveragedatefortheentirefiscalperiod.
55. Consider an issuer (public) company
whose purchases are made through the
Internet and by telephone. Which of the
followingiscorrect?
a. These types of purchases
represent control objectives for
theauditofinternalcontrol.
b. These purchases are the
assertions related to the
purchaseclassoftransactions.
c. Thesetypesofpurchases
representtwomajorclassesof
transactionswithinthe
purchasesprocess.
d. Thesetwotypesoftransactions
representroutinetransactions
thatmustalwaysbeinvestigated
inextremedetail.
56. Foranissuer(public)companyauditofinternalcontrol,
walkthroughsprovidetheauditorwith primaryevidence
to
a.
b.
c.
d.
Evaluatethe
effectivenessofthe
designofcontrols
Yes
Yes
No
No
Confirmwhether
controlshavebeen
placedinoperation
Yes
No
Yes
No
57. Whichismostlikelytobeaquestion
askedofemployeepersonnelduringa
walkthroughinanauditoftheinternal
controlofanissuer(public)company?
a. Have you ever been asked to override the
process?
b.
d.
No
No
Yes
No
Doyoubelievethatyouareunderpaid?
c. Whatdoyoudowhenyou
find a fraudulent
transaction?
Whotrainedyouforthisjob?
58. Howlargemusttheactuallossidentifiedby
the auditor be for a control deficiency to
possiblybeconsideredamaterialweakness?
a.
b.
Immaterial
Yes
Yes
Material
Yes
No
71
59. Forpurposesofanauditofinternalcontrol
performedunderPublicCompany
AccountingOversightBoardrequirements,
anaccountissignificantifthereismorethan
a
a.
b.
c.
d.
possible
likelihood that it could
contain
material
misstatements.
Remotelikelihoodthatitcould
containmaterialmisstatements.
Remote likelihood that it could
containmorethaninconsequential
misstatements.
60. Acontroldeficiencythatismorethanasignificant
deficiencyismostlikelytoresultinwhatformof
auditopinionrelatingtointernalcontrol?
a. Adverse.
b. Qualified.
c. Unqualified.
d. Unqualifiedwithexplanatorylanguage.
61. Whichofthefollowingismostlikelytobeconsidered
amaterialweaknessininternalcontrolforpurposesof
aninternalcontrolauditofanissuer(public)
company?
a. An ineffective oversight of
financial reporting by the audit
committee.
b.
c.
d.
Inadequate segregation of
recordkeepingfromaccounting.
Weaknessesincontrolactivities.
62. Inabilitytoevaluateinternalcontroldueto
a.
b.
c.
d.
acircumstancecausedscopelimitation
relatingtoasignificantaccountina
SarbanesOxley404internalcontrolaudit
ismostlikelytoresultina(n)
Adverseopinion.
Qualifiedopinion.
Unqualified opinion with explanatory
language.
Alloftheaboveareequallylikely.
a.
Abroadscopeofinternalauditactivities.
b. A whistleblower program
that encourages anonymous
submissions.
c. Audit committee passivity when
conductingoversightfunctions.
d.
Lack of performance of
criminal
background
investigations for likely
customers.
64. Anauditoridentifiedamaterialweaknessin
December.Theclientwasinformedandcorrectedit
shortlyaftertheasofdate(December31);the
auditoragreesthatthecorrectioneliminatesthe
materialweaknessasofJanuary31.Theappropriate
reportunderaPCAOBStandard5auditofinternal
controlis
a. Adverse.
b. Unqualified.
c. Unqualified with explanatory
language relating to the material
weakness.
d. Qualified.
65. In an integrated audit, which of the
followinglead(s)toanadverseopinionon
internalcontrol?
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
72
a.
b.
c.
d.
Material
weaknesses
Yes
Yes
No
No
Significant
deficiencies
Yes
No
Yes
No
66.Inanintegratedaudit,whatmusttheauditor
communicatetotheauditcommittee?
a.
b.
c.
d.
Knownmaterial
weaknesses
Yes
Yes
No
No
Allcontrol
deficiencies
Yes
No
Yes
No
67. Inwhichmanneraresignificantdeficiencies
communicatedbytheauditorstotheaudit
committeeunderPublicCompany
AccountingOversightBoardStandard5?
a. Thecommunicationmayeitherbeorallyorin
writtenform.
b. Thecommunicationmustbeoral,
andnotinwrittenform.
c. Thecommunicationmustbeinwrittenform.
d. No such communication is
required as only material
weaknesses must be
communicated.
68. Whichiscorrectconcerningtheexternal
auditorsuseoftheworkofothersinan
auditofinternalcontrolperformedfora
publiccompany?
a. Itisnotallowed.
b. Theworkofinternalauditorsmay
beused,butonlywhenthose
internalauditorsreportdirectlyto
theauditcommittee.
c. Ordinarily the work of internal
auditors and others is used
primarilyinlowriskareas.
d. Thereisnolimitationandislikely
to reduce auditor liability since
the auditors will then share legal
responsibilitywiththosewhohave
performedtheservice.
69. Inanintegratedaudit,whichmust
theauditorcommunicateinwriting
tomanagement?
a. Onlymaterialweaknesses.
b. Material weaknesses and significant
deficiencies.
c. Material weaknesses, significant
deficiencies and other control
deficiencies.
d. Materialweaknesses,significantdeficiencies,
othercontroldeficiencies, andallsuspected
andpossibleemployeelawviolations.
70. Whichofthefollowingiscorrectwhen
applyingatopdownapproachtoidentify
controlstotestinanintegratedaudit?
a. Forcertainassertions,strong
entitylevelcontrolsmayallow
theauditortoomitadditional
b.
c.
d.
testingbeyondthosecontrols.
Starting at the topcontrols
over specific assertionsthe
auditor should link to major
accountsandreportingitems.
Thegoalistofocusondetailsof
accountingcontrols,while
avoidingconsiderationofoverall
entitylevelcontrols.
Thegoalistofocusonallcontrols
relatedtoassertions,omitting
considerationofcontrolsrelatedto
thefinancialstatements.
wereaccountedfor.
71. Whichofthefollowingisnotincludedina
standard unqualified opinion on internal
controloverfinancialreportingperformed
underPCAOBrequirements?
a.
b.
Becauseofinherentlimitations,
internalcontroloverfinancial
reportingmaynotpreventordetect
misstatements.
Inouropinion,[companyname]maintained,
in all material respects, effective internal
controloverfinancialreporting.
c. Our audit included obtaining an
understanding of internal control
overfinancialreporting.
d.
The[companyname]management
andauditcommitteeisresponsible
formaintainingeffectiveinternal
controloverfinancialreporting.
72. Walkthroughsordinarilyprovideevidence
thathelpstheauditorto
a.
b.
c.
d.
Evaluatedesign
effectivenessof
controls
Yes
Yes
No
No
Confirmwhether
controlshavebeen
placedin
Operation
Yes
No
Yes
No
73. Whichofthefollowingprocedureswouldan
auditormostlikelyperformtotestcontrols
relatingtomanagementsassertionaboutthe
completenessofcashreceiptsforcashsales
ataretailoutlet?
a. Observe the consistency of the
employees use of cash registers
andtapes.
b. Inquireaboutemployees access
torecordedbutundepositedcash.
c. Trace deposits in the cash
receipts journal to the cash
balanceinthegeneralledger.
d. Comparethecashbalanceinthe
general ledger with the bank
confirmationrequest.
74. Soundinternalcontroldictatesthat
immediatelyuponreceivingchecksfrom
customersbymail,aresponsibleemployee
should
a. Addthecheckstothedailycashsummary.
b. Verify that each check is
supportedbyaprenumberedsales
invoice.
c. Prepareaduplicatelistingofchecksreceived.
d. Record the checks in the cash receipts
journal.
75. Tracing shipping documents to
prenumbered sales invoices provides
evidencethat
a. Noduplicateshipmentsorbillingsoccurred.
b. Shipments to customers were properly
invoiced.
c. All goods ordered by customers were
shipped.
d. All prenumbered sales invoices
76. Whichofthefollowingcontrolsmostlikelywouldre
ducetheriskofdiversionofcustomerreceiptsbyan
entitysemployees?
a. Abanklockboxsystem.
b. Prenumberedremittanceadvices.
c. Monthlybankreconciliations.
d. Dailydepositofcashreceipts.
77. Anauditorsuspectsthataclientscashieris
misappropriating cash receipts for personal
use by lapping customer checks received in
themail.Inattemptingtouncoverthis
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
embezzlementscheme,theauditormostlikelywould
comparethe
a. Dateschecksaredepositedper
bank statements with the dates
remittancecreditsarerecorded.
b. Dailycashsummarieswiththesumsofthe
cashreceiptsjournalentries.
c. Individual bank deposit slips with
the details of the monthly bank
statements.
d. Datesuncollectibleaccountsareauthorizedto
bewrittenoffwiththedatesthewriteoffsare
actuallyrecorded.
78. Uponreceiptofcustomerschecksinthe
mailroom,aresponsibleemployeeshould
preparearemittancelistingthatisforwarded
tothecashier.Acopyofthelistingshouldbe
senttothe
a. Internal auditor to investigate
the listing for unusual
transactions.
b. Treasurer to compare the listing
withthemonthlybankstatement.
c. Accountsreceivablebookkeeperto
update the subsidiary accounts
receivablerecords.
d. Entitys bank to compare the
listing with the cashiers deposit
slip.
79. Whichofthefollowingproceduresmost
likelywouldnotbeacontroldesignedto
reducetheriskofmisstatementsinthebilling
process?
a.
b.
c.
d.
80. Whichofthefollowingauditprocedureswouldan
auditormostlikelyperformtotestcontrolsrelatingto
managementsassertionconcerningthecompleteness
ofsalestransactions?
a. Verifythatextensionsand
footingsontheentityssales
invoicesandmonthlycustomer
statementshavebeenrecomputed.
b. Inspecttheentitysreportsof
prenumberedshippingdocuments
thathavenotbeenrecordedinthe
salesjournal.
c. Compare the invoiced prices on
prenumbered sales invoices to the
d.
entitysauthorizedpricelist.
Inquireaboutthe entitys credit
granting policies and the
consistent application of credit
checks.
73
81. Whichofthefollowingcontrolsmostlikely
would assure that all billed sales are
correctlypostedtotheaccountsreceivable
ledger?
a. Daily sales summaries are
comparedtodailypostingstothe
accountsreceivableledger.
b. Eachsalesinvoiceissupportedby
a prenumbered shipping
document.
c. Theaccountsreceivableledgeris
reconciled daily to the control
accountinthegeneralledger.
d. Each shipment on credit is
supportedbyaprenumberedsales
invoice.
Theaccountingdepartmentsupervisorcontrols
themailingofmonthlystatementstocustomers
andinvestigatesanydifferencesreportedby
customers.
d.
Thebillingdepartmentsupervisor
matchesprenumberedshipping
documentswithentriesinthe
salesjournal.
84. Whichofthefollowingcontrolsmostlikely
wouldbeeffectiveinoffsettingthe
tendencyofsalespersonneltomaximize
salesvolumeattheexpenseofhighbad
debtwriteoffs?
a.
b.
Shippingdocumentsandsales
c.
invoicesarematchedbyan
employeewhodoesnothaveau
thoritytowriteoffbaddebts.
Employees involved in the creditgranting
function are separated from the sales
function.
d.
85. Properauthorizationofwriteoffsof
uncollectibleaccountsshouldbe
approvedinwhichofthefollowingde
partments?
a. Accountsreceivable.
b. Credit.
c. Accountspayable.
d. Treasurer.
86. Employers bond employees who handle
cashreceiptsbecausefidelitybondsreduce
the possibility of employing dishonest
individualsand
a. Protect employees who make
unintentional misstatements
frompossiblemonetarydamages
resulting from their
misstatements.
b. Deterdishonestybymaking
employeesawarethatinsurance
companiesmayinvestigateand
prosecutedishonestacts.
c. Facilitate an independent
monitoring of the receiving and
depositingofcashreceipts.
d.
87. Duringtheconsiderationofasmallbusiness
clientsinternalcontrol,theauditor
discoveredthattheaccountsreceivableclerk
approvescreditmemosandhasaccessto
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
74
andreceivingreports.
cash.Whichofthefollowingcontrolswouldbemost
effectiveinoffsettingthisweakness?
a. The owner reviews errors in
billingstocustomersandpostings
tothesubsidiaryledger.
b.
c.
d.
Theownerreviews creditmemos
aftertheyarerecorded.
Thecontrollerreconcilesthetotal
of the detail accounts receivable
accounts to the amount shown in
theledger.
88. Whenacustomerfailstoincludearemittanceadvice
withapayment,itiscommonpracticefortheperson
openingthemailtoprepareone.Consequently,mail
shouldbeopenedbywhichofthefollowingfour
companyemployees?
a.
b.
c.
d.
Creditmanager.
Receptionist.
Salesmanager.
Accountsreceivableclerk.
89. Toprovideassurancethateachvoucheris
submittedandpaidonlyonce,anauditor
mostlikelywouldexamineasampleofpaid
vouchersanddeterminewhethereach
voucheris
a. Supportedbyavendorsinvoice.
b. Stampedpaidbythechecksigner.
c. Prenumberedandaccountedfor.
d. Approvedforauthorizedpurchases.
90. Intestingcontrolsovercashdisbursements,
anauditormostlikelywoulddeterminethat
thepersonwhosignschecksalso
a. Reviewsthemonthlybankreconciliation.
b. Returnsthecheckstoaccountspayable.
c. Is denied access to the supporting
documents.
d. Isresponsibleformailingthechecks.
91. Inassessingcontrolriskforpurchases,an
auditorvouchesasampleofentriesinthe
voucherregistertothesupporting
documents.Whichassertionwouldthis
testofcontrolsmostlikelysupport?
a. Completeness.
b. Existenceoroccurrence.
c. Valuationorallocation.
d. Rightsandobligations.
92. Whichofthefollowingcontrolsis not
usually performed in the vouchers
payabledepartment?
a. Matching the vendors invoice
withtherelatedreceivingreport.
b. Approving vouchers for payment
byhavinganauthorizedemployee
signthevouchers.
c. Indicating the asset and
expenseaccountstobedebited.
d. Accounting for unused
prenumbered purchase orders
93. Withproperlydesignedinternalcontrol,the
sameemployeemostlikelywouldmatch
vendors invoices with receiving reports
andalso
a. Postthedetailedaccountspayablerecords.
b. Recompute the calculations on vendors
invoices.
c. Reconciletheaccountspayableledger.
d. Cancelvendorsinvoicesafterpayment.
94. Anentitysinternalcontrolrequiresfor
everycheckrequestthattherebean
approvedvoucher,supportedbya
prenumberedpurchaseorderandaprenumbered
receivingreport.Todeterminewhetherchecksare
beingissuedforunauthorizedexpenditures,anauditor
mostlikelywouldselectitemsfortestingfromthe
populationofall
a.
b.
c.
d.
Purchaseorders.
Canceledchecks.
Receivingreports.
Approvedvouchers.
d.
96. Foreffectiveinternalcontrol,theaccounts
payabledepartmentgenerallyshould
a.
b.
Ascertainthateachrequisitionis
approved as to price, quantity,
and quality by an authorized
employee.
Obliteratethequantityorderedon
thereceivingdepartmentcopyof
thepurchaseorder.
c.
d.
97. Internalcontrolisstrengthenedwhenthe
quantity of merchandise ordered is
omittedfromthecopyofthepurchase
ordersenttothe
a. Departmentthatinitiatedtherequisition.
b. Receivingdepartment.
c. Purchasingagent.
d. Accountspayabledepartment.
98. Aclienterroneouslyrecordedalarge
purchasetwice.Whichofthefollowing
internalcontrolmeasureswouldbemost
likelytodetectthiserrorinatimelyand
efficientmanner?
a. Footingthepurchasesjournal.
b. Reconciling vendors monthly statements
withsubsidiarypayableledgeraccounts.
c. Tracing totals from the
purchasesjournaltotheledger
d.
accounts.
Sending written quarterly
confirmationstoallvendors.
99. Withwelldesignedinternalcontrol,
employeesinthesamedepartmentmost
likelywouldapprovepurchaseorders,
andalso
a. Reconciletheopeninvoicefile.
b. Inspectgoodsuponreceipt.
c. Authorizerequisitionsofgoods.
d. Negotiatetermswithvendors.
100. Inobtaininganunderstandingofa
manufacturingentitysinternalcontrol
overinventorybalances,anauditormost
likelywould
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
a.
b.
c.
d.
Purchasingclerk.
Receivingclerk.
Inventorycontrolclerk.
75
Analyzetheliquidityandturnover
ratiosoftheinventory.
b. Perform analytical procedures 105. AlphaCompanyusesitssalesinvoicesforpostingper
petualinventoryrecords.Inadequatecontrolsoverthe
designedtoidentifycostvariances.
invoicingfunctionallowgoodstobeshippedthatare
c. Reviewtheentitysdescriptionsof
notinvoiced.Theinadequatecontrolscouldcausean
inventory policies and
a. Understatement of revenues,
procedures.
receivables,andinventory.
d. Perform test counts of inventory
b. Overstatement of revenues and
duringtheentitysphysicalcount.
receivables,andanunderstatement
101. Whichofthefollowingcontrolsmostlikely
ofinventory.
would be used to maintain accurate
c. Understatement ofrevenues and
inventoryrecords?
receivables,andanoverstatement
a. Perpetual inventory records are
ofinventory.
periodically compared with the
d. Overstatement of revenues,
current cost of individual
receivables,andinventory.
inventoryitems.
b. A justintime inventory ordering
systemkeepsinventorylevelstoa
desiredminimum.
c. Requisitions,receivingreports,
andpurchaseordersare
independentlymatchedbefore
paymentisapproved.
d. Periodic inventory counts are
used to adjust the perpetual
inventoryrecords.
102. A client maintains perpetual inventory
recordsinbothquantitiesanddollars.Ifthe
assessed level of control risk is high, an
auditorwouldprobably
a. Insist that the client perform
physical counts of inventory
items several times during the
year.
b. Applygrossprofitteststoascertain
thereasonablenessofthephysical
counts.
c. Increase the extent of tests of
controlsoftheinventorycycle.
d. Requesttheclienttoschedulethe
physical inventory count at the
endoftheyear.
103. Whichofthefollowingcontrolsmostlikely
addresses the completeness assertion for
inventory?
a. Work in process account is
periodically reconciled with
subsidiaryrecords.
b. Employees responsible for
custody of finished goods do
not perform the receiving
function.
c. Receiving reports are
prenumbered and periodically
reconciled.
d. There is a separation of duties
between payroll department and
inventoryaccountingpersonnel.
104. Soundinternalcontroldictatesthatdefective
merchandisereturnedbycustomersshould
bepresentedinitiallytothe
a. Salesclerk.
106. Whichofthefollowingisaquestionthat
the auditor would expect to find on the
production cycle section of an internal
controlquestionnaire?
a. Arevendorsinvoicesforraw
materialsapprovedforpaymentby
anemployeewhoisindependentof
thecashdisbursementsfunction?
b. Aresignedchecksforthe
purchaseofrawmaterialsmailed
directlyaftersigningwithout
beingreturnedtothepersonwho
authorizedtheinvoice
processing?
c. Areallreleasesbystorekeepers
ofrawmaterialsfromstorage
basedonapprovedrequisition
documents?
d. Aredetailsofindividual
disbursementsforrawmaterials
balancedwiththetotaltobeposted
totheappropriategeneralledger
account?
107. Theobjectivesofinternalcontrolfora
productioncyclearetoprovideassurance
thattransactionsareproperlyexecutedand
recorded,andthat
a. Production orders are prenumbered and
signedbyasupervisor.
b. Custodyof workinprocessand
of finished goods is properly
maintained.
c. Independentinternalverificationof
activityreportsisestablished.
d. Transferstofinishedgoodsare
documentedbyacompleted
productionreportandaquality
controlreport.
108. An auditor vouched data for a sample of
employeesinapayrollregistertoapproved
clockcarddatatoprovideassurancethat
a. Payments to employees are
b.
c.
d.
computedatauthorizedrates.
Employeesworkthenumberof
hoursforwhichtheyarepaid.
Segregationofdutiesexistbetween
thepreparationanddistributionof
thepayroll.
Controls relating to unclaimed
payroll checks are operating
effectively.
109. Whichofthefollowingisacontrolthat
mostlikelycouldhelppreventemployee
payrollfraud?
a. Thepersonneldepartment
promptlysendsemployee
terminationnoticestothepayroll
supervisor.
b. Employeeswhodistributepayroll
checksforwardunclaimedpayroll
checkstotheabsentemployees
supervisors.
c. Salary rates resulting from new
hiresareapprovedbythepayroll
supervisor.
d. Totalhoursusedfordetermination
ofgrosspayarecalculatedbythe
payrollsupervisor.
110. Indeterminingtheeffectivenessofanentitys
controlsrelatingtotheexistenceoroccurrence
assertionforpayrolltransactions,anauditor
mostlikelywouldinquireaboutand
a. Observe the segregation of duties
concerning
personnel
responsibilities and payroll
disbursement.
b.
c.
d.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
76
111. Anauditormostlikelywouldassesscontrol
riskatahighlevelifthepayrolldepartment
supervisorisresponsiblefor
a. Examining authorization forms for new
employees.
b. Comparing payroll registers
with original batch transmittal
data.
c. Authorizing payroll rate changes for all
employees.
d. Hiring all subordinate payroll
departmentemployees.
112. Whichofthefollowingcontrolsmost
likelywouldpreventdirectlaborhours
frombeingchargedtomanufacturing
overhead?
a. Periodic independent counts of
workinprocessforcomparisonto
recordedamounts.
b. Comparison of daily journal
entries with approved production
orders.
c. Use of time tickets to record
actual labor worked on
productionorders.
d. Reconciliationofworkinprocess
inventory with periodic cost
budgets.
113. In meeting the control objective of
safeguarding of assets, which department
shouldberesponsiblefor
a.
b.
c.
d.
Distribution
ofpaychecks
Treasurer
Payroll
Treasurer
Payroll
Custodyof
unclaimedpaychecks
Treasurer
Treasurer
Payroll
Payroll
a.
b.
c.
d.
unclaimedcashpayrollshouldbe
Depositedinasafedepositbox.
Heldbythepayrollcustodian.
Depositedinaspecialbankaccount.
Heldbythecontroller.
117. Theauditormayobservethedistributionof
paycheckstoascertainwhether
a. Payrateauthorizationisproperly
separated from the operating
function.
b. Deductions from gross pay are
calculated correctly and are
properlyauthorized.
c. Employees of record actually
existandareemployedbythe
client.
d.
Paychecksagreewiththepayroll
registerandthetimecards.
118. Whichofthefollowingdepartmentsmostlikelywould
approve changes in pay rates and deductions from
employeesalaries?
a. Personnel.
b. Treasurer.
c. Controller.
d. Payroll.
d.
121. Wherenoindependentstocktransferagents
areemployedandthecorporationissuesits
ownstocksandmaintainsstockrecords,
canceledstockcertificatesshould
a.
119. Whichofthefollowingquestionswouldan
auditormostlikelyincludeonaninternal
controlquestionnairefornotespayable?
a.
b.
c.
d.
120. Theprimaryresponsibilityofabankactingasregistrar
ofcapitalstockisto
a. Ascertainthatdividendsdeclared
do not exceed the statutory
amountallowableinthestateof
incorporation.
b. Account for stock certificates by
comparing the total shares
outstanding to the total in the
shareholderssubsidiaryledger.
c. Actasanindependentthirdparty
betweentheboardofdirectorsand
outsideinvestorsconcerning
mergers,acquisitions,andthesale
oftreasurystock.
Verifythatstockisissuedin
accordancewiththeauthorization
oftheboardofdirectorsandthe
articlesofincorporation.
c.
d.
Bedefacedtopreventreissuance
and attached to their
correspondingstubs.
b. Notbedefacedbutsegregated
fromotherstockcertificatesand
retainedinacanceledcertificates
file.
Be destroyed to prevent fraudulent
reissuance.
Bedefacedandsenttothesecretaryofstate.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
a.
Theinvestmentcommitteeoftheboardofdirectors128.Whichofthefollowingcontrolswouldanentitymost
periodicallyreviewstheinvestment
investments are executed on the
decisionsdelegatedtothetreasurer.
specificauthorizationoftheboard
ofdirectors.
b. Twocompanyofficialshavejoint
controlofmarketablesecurities,
d. The recorded balances in the
whicharekeptinabanksafe
investment subsidiary ledger are
depositbox.
periodically compared with the
contentsofthesafedepositboxby
c. Theinternalauditorandthecontroller
independentpersonnel.
independentlytraceallpurchasesandsales
ofmarketablesecuritiesfromthesubsidiary
127. Acompanyholdsbearerbondsasashort
ledgerstothegeneralledger.
terminvestment.Responsibilityforcustody
d. Thechairmanoftheboardverifies
ofthesebondsandsubmissionofcoupons
themarketablesecurities,whichare
forperiodicinterestcollectionsprobably
keptinabanksafedepositbox,
shouldbedelegatedtothe
eachyearonthebalancesheetdate.
a. ChiefAccountant.
b. InternalAuditor.
124. A weakness in internal control over
c. Cashier.
recording retirements of equipment may
d. Treasurer.
causeanauditorto
a. Inspectcertainitemsofequipment
intheplantandtracethoseitemsto
theaccountingrecords.
b. Review the subsidiary ledger to
ascertainwhetherdepreciationwas
takenoneachitemofequipment
duringtheyear.
c. Trace additions to the other
assets account to search for
equipmentthatis stillon hand
butnolongerbeingused.
d. Select certain items of
equipment from the ac
counting records and locate
themintheplant.
125. Whichofthefollowingquestionswouldan
auditorleastlikelyincludeonaninternal
controlquestionnaireconcerningthe
initiationandexecutionofequipment
transactions?
a.
b.
Areprenumberedpurchaseorders
used for equipment and
periodicallyaccountedfor?
Are requests for purchases of
equipment reviewed for
consideration of soliciting
competitivebids?
Are procedures in place to
monitor and properly restrict
accesstoequipment?
c.
d.
126. Whichofthefollowingcontrolswouldbe
mosteffectiveinassuringthattheproper
custodyofassetsintheinvestingcycleis
maintained?
a. Directaccesstosecuritiesinthesafedeposit
boxislimitedtoonlyonecorporateofficer.
b. Personnel who post investment
transactionstothegeneralledger
arenotpermittedtoupdatethein
vestmentsubsidiaryledger.
c. The purchase and sale of
77
likelyusetoassistinsatisfyingthecompleteness
assertionrelatedtolongterminvestments?
a. Seniormanagementverifiesthat
securitiesinthebanksafedeposit
boxareregisteredintheentitys
name.
b.
c.
Thetreasurervouchesthe
acquisitionofsecuritiesby
comparingbrokersadviceswith
canceledchecks.
The controller compares the
currentmarketpricesofrecorded
investments with the brokers
advicesonfile.
d.
129. Whichofthefollowingcontrolswouldan
entitymostlikelyuseinsafeguarding
againstthelossofmarketablesecurities?
a.
Anindependenttrustcompanythathasno
directcontactwiththeemployeeswhohave
recordkeepingresponsibilitieshaspossession
ofthesecurities.
b.
c.
d.
Theinternalauditorverifiesthe
marketablesecuritiesinthe
entityssafeeachyearonthe
balancesheetdate.
Theindependentauditortracesall
purchasesandsalesofmarketable
securitiesthroughthesubsidiary
ledgerstothegeneralledger.
Adesignatedmemberoftheboard
ofdirectorscontrolsthesecurities
inabanksafedepositbox.
130. Whentherearenumerouspropertyand
equipmenttransactionsduringtheyear,an
auditorwhoplanstoassesscontrolriskata
lowlevelusuallyperforms
a.
b.
b.
Theauditormustcommunicate
both material weaknesses and
significantdeficiencies.
Theauditormustcommunicateinwriting.
c.
d.
Previously
communicated
weaknesses that have not been
corrected need not be
recommunicated.
Acommunicationindicatingthat
nosignificantdeficiencieswere
identifiedshouldnotbeissued.
133. Whichofthefollowingmatterswouldan
auditormostlikelyconsidertobeamaterial
weaknesstobecommunicatedtothose
chargedwithgovernanceofanauditclient?
a.
Managements failure to
renegotiate unfavorable long
termpurchasecommitments.
78
b.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
Recurringoperatinglossesthatmayindicategoing138.Whichofthefollowingrepresentationsshouldnotbe
concernproblems.
a. Significant deficiencies are material weaknesses
in the design or operation of specific internal
c. Ineffective oversight of financial
controlcomponents.
reporting by those charged with
governance.
b. Theauditorisobligatedtosearchfor
significantdeficienciesthatcould
d. Managementscurrentplanstoreduce
adverselyaffecttheentitysabilityto
itsownershipequityintheentity.
recordandreportfinancialdata.
134. Which of the following statements is correct
c. Significantdeficienciesneednotbe
concerningsignificantdeficienciesinanaudit?
recommunicatedeachyearif
a. Anauditorisrequiredtosearchfor
managementhasacknowledgedits
significant deficiencies during an
understandingofsuchdeficiencies.
audit.
d. The auditor should separately
b. All significant deficiencies are also
communicate those significant
consideredtobematerialweaknesses.
deficiencies considered to be material
c. Anauditormaycommunicate
weaknesses.
significantdeficienciesduringan
auditoraftertheaudits
completion.
d.
Anauditormayreportthat no
significant deficiencies were
notedduringanaudit.
135. Anauditorsletterissuedonsignificant
deficienciesrelatingtoanentitysinternal
controlobservedduringafinancialstatement
auditshould
a. Includeabriefdescriptionofthetests
ofcontrolsperformedinsearchingfor
significantdeficienciesandmaterial
weaknesses.
b. Indicatethatthesignificantdeficiencies
shouldbedisclosedintheannualreport
totheentitysshareholders.
c. Includeaparagraphdescribing
managementsassertionconcerning
theeffectivenessofinternalcontrol.
d. Indicatethattheauditspurposewas
toreportonthefinancialstatements
andnottoexpressanopinionon
internalcontrol.
136. Whichofthefollowingstatementsiscorrect
concerninganauditorsrequired
communicationofsignificantdeficiencies?
a. Asignificantdeficiencypreviously
communicatedduringtheprioryears
auditthatremainsuncorrectedcausesa
scopelimitation.
b. Anauditorshouldperformtestsof
controlsonsignificantdeficiencies
beforecommunicatingthemtothe
client.
c. Anauditorsreportonsignificant
deficienciesshouldincludea
restrictiononthedistributionofthe
report.
d. Anauditorshouldcommunicate
significantdeficienciesaftertests
ofcontrols,butbefore
commencingsubstantivetests.
137. Which of the following statements is correct
concerningsignificantdeficienciesnotedinan
audit?
includedinareportoninternalcontrolrelatedmatters
notedinanaudit?
a. Significant deficiencies related to
internalcontrolexist.
b. There are no significant deficiencies
inthedesignoroperationofinternal
control.
c. Correctivefollowupactionis
recommendedduetotherelative
significanceofmaterialweaknesses
discoveredduringtheaudit.
d. Theauditorsconsiderationof
internalcontrolwouldnot
necessarilydiscloseallsignificant
deficienciesthatexist.
139. Which of the following statements concerning material
weaknessesandsignificantdeficienciesiscorrect?
a. An auditor should not identify and
communicate material weaknesses
separately from significant
deficiencies.
b. Compensating controls may limit the
severity of a material weakness or
significantdeficiency.
c.
Upondiscoveryanauditorshould
immediatelyreportallmaterial
weaknessesandsignificant
deficienciesidentifiedduringan
audit.
d.
140. Duringtheaudittheindependentauditor
identifiedtheexistenceofaweaknessinthe
clientsinternalcontrolandcommunicatedthis
findinginwritingtotheclientssenior
managementandthosechargedwithgovernance.
Theauditorshould
a.
b.
d.
141. Inidentifyingmattersforcommunicationwith
thosechargedwithgovernanceofanaudit
client,anauditormostlikelywouldask
managementwhether
a. The turnover in the accounting
departmentwasunusuallyhigh.
b. It consulted with another CPA firm
aboutaccountingmatters.
c. Therewereanysubsequenteventsof
whichtheauditorwasunaware.
d. It agreed with the auditors assessed
levelofcontrolrisk.
142. Which of the following statements is correct
concerninganauditorsrequiredcommunication
withthosechargedwithgovernanceofanaudit
client?
a. Thiscommunicationisrequiredtooccur
beforetheauditorsreportonthe
financialstatementsisissued.
b. Thiscommunicationshouldinclude
discussionofanysignificant
disagreementswithmanagement
concerningthefinancialstatements.
c. Anysignificantmattercommunicated
totheauditcommitteealsoshouldbe
communicatedtomanagement.
d. Significantauditadjustmentsproposed
bytheauditorandrecordedby
managementneednotbecommunicated
tothosechargedwithgovernance.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
143. An auditor would least likely initiate a discussion with
those charged with governance of an audit client b.
concerning
a. The methods used to account for
d.
significantunusualtransactions.
b. Themaximumdollaramountof
misstatementsthatcouldexistwithout
causingthefinancialstatementstobe
materiallymisstated.
c. Indicationsoffraudandillegalacts
committedbyacorporateofficerthat
werediscoveredbytheauditor.
d. Disagreementswithmanagementasto
accountingprinciplesthatwere
resolvedduringthecurrentyearsaudit.
144. Which of the following statements is correct
aboutanauditorsrequiredcommunicationwith
those charged with governance of an audit
client?
a. Anymatterscommunicatedtotheentitysaudit
committeealsoarerequiredtobecommunicated
totheentitysmanagement.
b. Theauditorisrequiredtoinform
thosechargedwithgovernanceabout
significantmisstatementsdiscovered
bytheauditorandsubsequentlycor
rectedbymanagement.
c. Disagreementswithmanagementabout
theapplicationofaccounting
principlesarerequiredtobe
communicatedinwritingtothose
chargedwithgovernance.
d. Weaknessesininternalcontrol
previouslyreportedtothosecharged
withgovernanceneednotbere
communicated.
145. Which of the following matters is an auditor
required to communicate to an entitys audit
committee?
I.
Disagreementswithmanagementaboutmatters
significanttotheentitysfinancialstatementsthat
havebeensatisfactorilyresolved.
AI. Initial selection of significant accounting
policies in emerging areas that lack
authoritativeguidance.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
NeitherInorII.
a.
b.
c.
d.
Significantaudit
adjustmentsrecorded
bytheentity
Yes
Yes
No
No
Managementsconsulta
tionwithotheraccoun
tantsaboutsignificant
accountingmatters
Yes
No
Yes
No
147.Inreportingonanentitysinternalcontroloverfinan
cial reporting, a practitioner should include a paragraph
79
thatdescribesthe
a. Documentary evidence regarding the control
environmentfactors.
Changesininternalcontrolsincethepriorreport.
c. Potential benefits from the practitioners
suggestedimprovements.
Inherentlimitationsofanyinternalcontrol.
audit?
148. WhichofthefollowingbestdescribesaCPAs
engagementtoreportonanentitysinternal
controloverfinancialreporting?
a. Anattestationengagementtoforman
opinion on the effectiveness of its
internalcontrol.
b. An audit engagement to provide
negative assurance on the entitys
internalcontrol.
c.
d.
Aprospectiveengagementtoproject,for
aperiodoftimenottoexceedoneyear,
and report on the expected benefits of
theentitysinternalcontrol.
A consulting engagement to provide
constructive adviceto theentity onits
internalcontrol.
a.
b.
c.
d.
Scope
Similar
Different
Different
Different
Procedures
Different
Similar
Different
Similar
Purpose
Similar
Similar
Different
Different
151. Whenanindependentauditorreportsoninternal
control based on criteria established by
governmentalagencies,thereportshould
a. Notincludetheagencysnameinthereport.
b.
Indicatematterscoveredbythestudyand
whethertheauditorsstudyincludedtests
of controls with the procedures covered
bythestudy.
c.
d.
Assumeresponsibilityforthe
comprehensivenessofthecriteria
establishedbytheagencyandinclude
recommendationsforcorrectiveaction.
152. Whenanexaminationhasbeenperformedonthe
effectivenessofentitysinternalcontrolover
financialreportingandamaterialweaknesshas
beennoted,thepractitionersreportshould
expressanopinionon
a. Theassertion.
b. Thesubjectmattertowhichtheassertionrelates.
c. Neitheroftheabove.
d. Bothoftheabove.
153. Inassessingthecompetenceofaninternal
auditor,anindependentCPAmostlikelywould
obtaininformationaboutthe
a. Quality of the internal auditors
workingpaperdocumentation.
b. Organizationscommitmenttointegrity
andethicalvalues.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
80
c.
Influenceofmanagementonthescopeoftheinter160.Iftheindependentauditorsdecidethattheworkper
formedbytheinternalauditormayhaveabearingontheir
nalauditorsduties.
ownprocedures,theyshouldconsidertheinternalauditors
d. Organizational level to which the
internalauditorreports.
a.
Competenceandobjectivity.
b.
Efficiencyandexperience.
154. Forwhichofthefollowingjudgmentsmayanindependent
c.
Independenceandreviewskills.
auditorshareresponsibilitywithanentitysinternalauditor
d.
Trainingandsupervisoryskills.
whoisassessedtobebothcompetentandobjective?
obtainedfrom
Assessmentof
Assessmentof
a. Discussionswithmanagementpersonnel.
inherentrisk
controlrisk
b. External quality reviews of the
a.
Yes
Yes
internalauditorsactivities.
b.
Yes
No
c.
No
Yes
c. Previousexperiencewiththeinternalauditor.
d.
No
No
d. Theresultsofanalyticalprocedures.
155.Theworkofinternalauditorsmayaffectthe
independentauditors
I.
a.
b.
c.
d.
IandIIonly.
IandIIIonly.
IIandIIIonly.
I,II,andIII.
156. Aninternalauditorsworkwouldmostlikely
affectthenature,timing,andextentofan
independentCPAsauditingprocedureswhen
theinternalauditorsworkrelatestoassertions
aboutthe
a. Existenceofcontingencies.
b. Valuationofintangibleassets.
c. Existenceoffixedassetadditions.
d. Valuationofrelatedpartytransactions.
157. Duringanauditaninternalauditormayprovide
directassistancetoanindependentCPAin
a.
b.
c.
d.
Obtainingan
understandingof
internalcontrol
No
Yes
Yes
Yes
Performing
testsof
controls
No
No
Yes
Yes
Performing
substantive
tests
No
No
No
Yes
retailer.Cook,CPA,isengagedtoexpressanopinionona
descriptionofPDCsinternalcontrolsimplementedasofa
specificdate.Thesecontrolsarerelevanttotheretailers
internalcontrol,soCooksreportmaybeusefulinproviding
theretailersindependentauditorwithinformationnecessary
toplanafinancialstatementaudit.Cooksreportshould
a.
b.
c.
d.
Implemented
Yes
Yes
No
No
Operatingeffectiveness
Yes
No
Yes
No
165.ComputerServicesCompany(CSC)processes
payrolltransactionsforschools.Drake,CPA,isengagedto
reportonCSCspoliciesandproceduresimplementedasofa
specificdate.Thesepoliciesandproceduresarerelevantto
theschoolsinternalcontrol,soDrakesreportwillbeuseful
inprovidingtheschoolsindependentauditorswithinfor
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
mationnecessarytoplantheiraudits.Drakesreport
expressinganopiniononCSCspoliciesand
proceduresimplementedasofaspecificdateshould
containa(n)
a. Descriptionofthescopeandnatureof
Drakesprocedures.
b.
StatementthatCSCsmanagementhas
disclosed to Drake all design
deficienciesofwhichitisaware.
c.
d.
166. Lake,CPA,isauditingthefinancialstatements
ofGillCo.GillusestheEDPServiceCenter,
Inc.toprocessitspayrolltransactions.EDPs
financialstatementsareauditedbyCope,CPA,
whorecentlyissuedareportonEDPsinternal
control.LakeisconsideringCopesreporton
EDPsinternalcontrolinassessingcontrolrisk
ontheGillengagement.WhatisLakes
responsibilityconcerningmakingreferenceto
Copeasabasis,inpart,forLakesownopin
ion?
a. LakemayrefertoCopeonlyifLake
issatisfiedastoCopesprofessional
reputationandindependence.
b. LakemayrefertoCopeonlyif
LakereliesonCopesreportin
restrictingtheextentofsubstantive
tests.
c. Lake may refer to Cope only if
Lakesreportindicatesthedivision
ofresponsibility.
d. Lake may not refer to Cope
underthecircumstancesabove.
81
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
82
SIMULATIONS
TaskBasedSimulation1
CashReceipts
andBilling
Authoritative
Literature
Help
AnauditorsworkingpapersincludethenarrativedescriptionofthecashreceiptsandbillingportionsofSouthwest
MedicalCentersinternalcontrol.Evaluatetheinformationinthesituationasbeingeither(1)astrength,(2)aweakness,(3)not
astrengthoraweakness.
Southwestisahealthcareproviderthatisownedbyapartnershipoffivephysicians.Itemployselevenphysicians,in
cludingthefiveowners,twentynurses,fivelaboratoryandXraytechnicians,andfourclericalworkers.Theclericalworkers
performsuchtasksasreception,correspondence,cashreceipts,billing,accountsreceivable,bankdeposits,andappointment
scheduling.Theseclericalworkersarereferredtointhesituationasofficemanager,clerk#1,clerk#2,andclerk#3.Assume
thatthenarrativeisacompletedescriptionofthesystem.
AbouttwothirdsofSouthwestspatientsreceivemedicalservicesonlyafterinsurancecoverageisverifiedbytheoffice
managerandcommunicatedtotheclerks.Mostoftheotherpatientspayforservicesbycashorcheckwhenservicesare
rendered,althoughtheofficemangerextendscreditonacasebycasebasistoabout5%ofthepatients.
Whenservicesarerendered,theattendingphysicianpreparesaprenumberedserviceslipforeachpatientandgivesthe
sliptoclerk#1forpricing.Clerk#1completestheslipandgivesthecompletedsliptoclerk#2andacopytothepatient.
Usingtheinformationonthecompletedslip,clerk#2performsoneofthefollowingthreeproceduresforeachpatient:
Clerk#2filesaninsuranceclaimandrecordsareceivablefromtheinsurancecompanyiftheofficemanagerhas
verifiedthepatientscoverage,or
Clerk#2postsareceivablefromthepatientonclerk#2sPCiftheofficemanagerhasapprovedthepatientscredit,or
Clerk#2receivescashoracheckfromthepatientasthepatientleavesthemedicalcenter,andclerk#2recordsthe
cashreceipt.
Attheendofeachday,clerk#2preparesarevenuesummary.
Clerk#1performscorrespondencefunctionsandopenstheincomingmail.Clerk#1giveschecksfrominsurancecompa
niesandpatientstoclerk#2fordeposit.Clerk#2poststhereceiptofpatientschecksonclerk#2sPCpatientreceivablerec
ordsandinsurancecompaniescheckstothereceivablesfromtheapplicableinsurancecompanies.Clerk#1givesmailre
quiringcorrespondencetoclerk#3.
Clerk#2stampsallchecksfordepositonlyandeachdaypreparesalistofchecksandcashtobedepositedinthebank.
(Thislistalsoincludesthecashandcheckspersonallygiventoclerk#2bypatients.)Clerk#2keepsacopyofthedepositlist
andgivestheoriginaltoclerk#3.
Clerk#3personallymakesthedailybankdepositandmaintainsafileofthedailybankdeposits.Clerk#3alsoperforms
appointmentschedulingforallofthedoctorsandvariouscorrespondencefunctions.Clerk#3alsomaintainsalistofpatients
whoseinsurancecoveragetheofficemanagerhasverified.
Wheninsuranceclaimsorpatientreceivablesarenotsettledwithinsixtydays,clerk#2notifiestheofficemanager.Theof
ficemanagerpersonallyinspectsthedetailsofeachinstanceofnonpayment.Theofficemangerconvertsinsuranceclaimsthat
havebeenrejectedbyinsurancecompaniesintopatientreceivables.Clerk#2recordsthesepatientreceivablesonclerk#2sPC
anddeletesthesereceivablesfromtheapplicableinsurancecompanies.Clerk#2deletesthepatientreceivablesthatappeartobe
uncollectiblefromclerk#2sPCwhenauthorizedbytheofficemanager.Clerk#2preparesalistofpatientswithuncollectible
balancesandgivesacopyofthelisttoclerk#3,whowillnotallowthesepatientstomakeappointmentsforfutureservices.
Onceamonthanoutsideaccountantpostsclerk#2sdailyrevenuesummariestothegeneralledger,preparesamonthly
trialbalanceandmonthlyfinancialstatements,accountsforprenumberedserviceslips,filespayrollformsandtaxreturns,and
reconcilesthemonthlybankstatementstothegeneralledger.Thisaccountantreportsdirectlytothephysicianwhoistheman
agingpartner.
AllfourclericalemployeesperformtheirtasksonPCsthatareconnectedthroughalocalareanetwork.EachPCisacces
siblewithapasswordthatisknownonlytotheindividualemployeeandthemanagingpartner.Southwestusesastandardsoft
warepackagethatwasacquiredfromasoftwarecompanyandthatcannotbemodifiedbySouthwestsemployees.Noneofthe
clericalemployeeshaveaccesstoSouthwestscheckwritingabilities.
Foreachofthefollowingconditionsindicatewhetheritisastrength,weakness,orneither.
(checks) from patients
Condition
and records the cash
1. Southwest is involved only in medical services and has not
receipt.
diversifieditsoperations.
2.
3.
Insurancecoverageforpatientsisverifiedandcommunicatedtothe
clerksbytheofficemanagerbeforemedicalservicesarerendered.
Thephysicianwhorendersthemedicalservicesdocumentstheservicesona
prenumberedslipthatisusedforrecordingrevenueandasareceiptforthe
patient.
4.
Strength
Weakness
Neither
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
Condition
5.
8.
Southwestextendscreditratherthanrequiringcashorinsuranceinallcases.
6.
Theofficemanagerextendscreditonacasebycasebasisratherthan
usingaformalcreditsearchandestablishedcreditlimits.
7.
Theofficemanagerapprovestheextensionofcredittopatientsand
alsoapprovesthewriteoffsofuncollectiblepatientreceivables.
Clerk#2receivescashandchecksandpreparesthedailybankdeposit.
9.
Clerk#2maintainstheaccountsreceivablerecordsandcanaddor
deleteinformationonthePC.
10. Prenumberedserviceslipsareaccountedforonamonthlybasisby
theoutsideaccountantwhoisindependentoftherevenue
generatingandrevenuerecordingfunctions.
83
Strength
Weakness
Neither
11. Thebankreconciliationispreparedmonthlybytheoutsideaccountantwhois
independentoftherevenuegeneratingandrevenuerecordingfunctions.
12. Computerpasswordsareonlyknowntotheindividualemployeesandthe
managingpartnerwhohasnodutiesintherevenuerecordingfunctions.
13. ComputersoftwarecannotbemodifiedbySouthwestsemployees.
14. Noneoftheemployeeswhoperformdutiesintherevenuegenerating
andrevenuerecordingareabletowritechecks.
TaskBasedSimulation2
Purchasesand
Disbursements
Authoritative
Literature
Help
Thefollowingflowchartdepictspartofaclientspurchasesandcashdisbursementscycle.Someoftheflowchartsymbols
arelabeledtoindicateoperations,controls,andrecords.Foreachsymbolnumbered1through12,selectoneresponsefromthe
answerlistsbelow.Eachresponseinthelistsmaybeselectedonceornotatall.
Connectors,documents,departments,andfiles
Operationsandcontrols
J.Accountspayable
O.PurchaseorderNo.5
A. Approvereceivingreport
K.Canceledvoucher
P.ReceivingreportNo.1
B. Prepareandapprovevoucher
package
Q.Stores
C. Preparepurchaseorder
L.Frompurchasing
R.Tovendor
D. Preparepurchaserequisition
M.Fromreceiving
S.Treasurer
E. Preparepurchasesjournal
N.Fromvouchers
T.Unpaidvoucherfile,
F. Preparereceivingreport
payable
filedbyduedate
G. Preparesalesjournal
H. Preparevoucher
I.
Signchecksandcancelvoucherpackagedocuments
PURCHASING
RECEIV
ING
From
Purch.
From
Stores
Pur. Order
Approved
Requisition
4
4
Requisition
6
Receive
Goods
Match with
Pur. Order
Requisition
1
Pur. Order
5
Pur. Order
4
Pur. Order
VOUCHERS
PAYABLE
From
Vendor
Invoice
By
File Pending
Arrival of all
Documents
10
Name
Match
From
Vouchers
Payable
Voucher Package
Requisition
Pur. Order
Rec. Report
1
Invoice
Approved
1
Voucher
Review
1
5
Pur. Order
Purchase
Order
2
1
To
Stores
By
Number
1.
2.
3.
4.
5.
6.
To
Receiving
To
Vouchers
Payable
7.
8.
9.
10.
11.
12.
Pur. Order
Rec. Report
Rec. Report
Rec. Report
2
Receiving
1
Report
4
4
3
To Vouchers
Payable
To
Stores
By
Number
Docu-
ments
8
Vouc
her
R
e
q
ui
si
ti
o
n
Pur.
Ord
er
R
e
c.
R
e
p
o
rt
In
voi
ce
1
5
A
pp
ro
ve
d 1
Vouche
r
General
Accoun
By
9
To Trea-
On Due
surer
Date
ing
Documents,
Prepare Check &
Remittance Advice
11
Check Copy
Remittance
Signed Check
Remittance
1
Advice
12
By
Number
Cancelled
Voucher
Package File
To
Vendor
To
General
Accounting
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
85
TaskBasedSimulation3
Research
Authoritative
Literature
Help
InternalControlLimitations
InadiscussionwiththecontrollerofGemcon,thetopicoflimitationsofinternalcontrolarose.Relatedly,theProfessional
Standardsacknowledgethatinternalcontrolhascertainlimitationsthataffectfinancialstatementaudits.Searchthe
ProfessionalStandardstofindthelocationatwhichanumberoflimitationsarediscussedtogether.
Selections
A. AU
B. PCAOB
C. AT
D. AR
E.
F.
G.
H.
ET
BL
CS
QC
(A)(B)(C)(D)(E)(F)(G)(H)
1.
WhichtitleoftheProfessionalStandardsaddressesthisissue?
2.
Entertheexactsectionandparagraphnumbersthatdescribethelimitations.
TaskBasedSimulation4
Sales/Shipping
Process
Authoritative
Literature
Help
YouareworkingforSmith&Co.CPAs.ThefollowingpartiallycompletedflowchartdepictspartofWelcoreInc.,your
clientsrevenuecycle.Someoftheflowchartsymbolsarelabeledtoindicatecontrolsandrecords.Foreachsymbolnumbered
1though13,selectoneresponsefromalltheanswerlistsbelow.Eachresponseinthelistsmaybeselectedonceornotatall.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
86
SALESDEPT.
From
Custome
r
Cust.
Credit
File
WAREHOUSE
&
SHIPPING
DEPARTMENT
COMPUTER
PROCESSING
DEPARTMENT
COMPUTERIZEDORDER
PROGRAM:
1andperformeditchecks
andpreparesalesorder
From
Computer
COMPUTERIZEDSHIPPING
PROGRAM:
RetrieveOpenOrders;
AddShippingData;
TransfertoShippingFile;and
PrepareShippingDocuments
Processing
Dept.
SalesOrder
Customer
Purchase
Order
3
SalesOrder
SalesOrder
SalesOrder
Transmit
Customer
Datato
Computer
Customer
Purchase
Order
CustomerP.O.
SalesOrder
SalesOrder
2
1
To
Customer
2
1
To
Warehouse
andShipping
Dept.
ShippingDoc.
Shipping
Document
2
1
Accounts
Rec.
Master
File
Trans
action
10
File
File
File
COMPUTERIZEDBILLING
PROGRAM;
RetrieveShippingData;
EnterPriceData;
PrepareSales
TransactionFile;and
Sales
Inventory
Master
Shipping
COMPUTERIZEDUPDATE
PROGRAM;
Updatemasterfiles;
PrepareG/LTransaction
Summary,PrepareAccounts
ReceivableLedger,Prepare
AgedT/B,and11
To
Customer
2
1
TransmitShipping
Information
toComputer
SalesOrder
ShippingDoc.
General
Ledger
Transaction
Summary
Shipping
Accounts
Receivable
Ledger
12
To
To
Accounting
Accounting
To
Accounts
Receivable
1.
8.
2.
9.
3.
10.
4.
11.
5.
12.
6.
13.
13
To
Customer
Credit
Document
To
Customer
with
Goods
7.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
L.
M.
N.
O.
A.
B.
C.
D.
E.
F.
G.
H.
I.
J.
K.
Operationsandcontrols
Entershippingdata
Verifyagreementofsalesorderandshippingdocument
Writeoffaccountsreceivable
Towarehouseandshippingdepartment
Authorizeaccountreceivablewriteoff
Prepareagedtrialbalance
Tosalesdepartment
Releasegoodsforshipment
Toaccountsreceivabledepartment
Enterpricedata
Determinethatcustomerexists
Matchcustomerpurchaseorderwithsalesorder
Performcustomercreditcheck
Preparesalesjournal
Preparesalesinvoice
TaskBasedSimulation5
Research
Documents,journals,ledgers,andfiles
P. Shippingdocument
Q. Generalledgermasterfile
R. Generaljournal
S. Masterpricefile
T. Salesjournal
U. Salesinvoice
V. Cashreceiptsjournal
W. Uncollectibleaccountsfile
X. Shippingfile
Y. Agedtrialbalance
Z. Openorderfile
87
Authoritative
Literature
Help
InternalControlReporting
ThepresidentofWelcoreInc.,anonpublicauditclientofyourfirm,hasindicatedtoyouthathebelievesthat
hemaytakethecompanypublicinayearortwo.Heaskedyouwhether,inadditiontoyourreportonthe
financialstaments,yourfirmcanissueareportoninternalcontrolthathecouldmakeavailabletoanyindividualor
organizationhesodesired.Heindicatedthathewouldliketohavetworeportsasdopubliccompaniesoneon
thefinancialstatementsandoneonthecompanysinternalcontrol.
Selections
A. AU
B. PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
(A)(B)(C)(D)(E)(F)(G)(H)
1. WhichtitleoftheProfessionalStandardsaddressesthisissueandwillbe
helpfulinrespondingtohim?
2. Entertheexactsectionnumberthatprovidestheappropriateguidance.
TaskBasedSimulation6
PurchasingReceiving,
andAccountsPayable
Authoritative
Literature
Help
Thefollowingflowchartdepictstheactivitiesrelatingtothepurchasing,receiving,andaccountspayable
departmentsofModelCompany,Inc.AssumethatyouareasupervisingassistantassignedtotheModel
Companyaudit.
88
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
PURCHASIN
G
RECEIVIN
G
ACCOUNTSPAYABLE
From
From
Dept.
From
Head
Purchasing
Fro
m
From
Purchasing
Vendor
Receiving
PurchaseOrder
withQuantity
BlackedOut
Approved
Requisition
Formin
P.O.3
Requisition
Rec.Report
Invoice
Duplicate
GoodsRec'd
AssuresBest
Priceis
&Counted
Independently
ByVendor
Pending
Obtained&
Requestis
inSecure
Facility
Invoice
Matches4
Doc
&
Recomputes
Math
Accuracy
of
Invoices
Receipt
withinBudget
Limits
Prepares
VerifiesAdequacy
Approves&
Prepares3
Copy
4Copy
ofVendor'sPast
Receiving
Record&
Voucher
(Prenumbered)
Report
Prepares5
CopyPurchase
Order
ComparesInvoice
Quantity
&
Priceto
P.O.
&Rec.
Report
Quantity
Rec.
Requisition
Report
P.O.
P.O.5
Rec.Report
P.
O.
P.O.3
Requisition
P.O.
Rec.Report
Receiving
1
Vo
uch
er
Rec.Report
Vouche
r
Requisition
P.O.
Invoice
Report
Vou
cher
(Prenumbered)
PurchaseOrder1
(Prenumbered)
ByP.O.#
To
Accounts
Payable
To
Vendor
To
Accounts
Payable
To
Receiving
Dept.
ToDept.
Headfor
Count&
Quality
Check
To
Purchasing
To
General
Acctg.
RecordedinVoucher
Register&
Independently
ReconciledMonthly
toControlAccounts
ByP.O.#
By
Voucher#
To
Dept.
Head
JoeWerell,abeginningassistant,analyzedtheflowchartandhassupplementedtheflowchartbymakingcertaininquiries
ofthecontroller.Hehasconcludedthattheinternalcontroloverpurchasing,receiving,andaccountspayableisstrongandhas
providedthefollowinglistofwhathereferstoasinternalcontrolstrengths.Reviewhislistandforeachinternalcontrol
strengthindicatewhetheryouagreeordisagreethateachrepresentsastrength.
I
nP
r
P
1.
2.
3.
4.
5.
T
h
P
r
P
P
u
T
R
6.
7.
R
e
A
8.
9.
T
h
10. R
A
g
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
13. A
l
14. A
l
15. T
89
TaskBasedSimulation7
Research
Authoritative
Literature
Help
InternalControlCommunications
OntheAdamsaudityourfirmdiscoveredcertainimmaterialauditjudgmentsthattheclientsmanagementchose
nottorecord.Managementhasnowaskedyounottocommunicateanythingregardingtheseomittedentriestotheaudit
committeeafterall,theyareimmaterial.
Selections
A. AU
B. PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
(A)(B)(C)(D)(E)(F)(G)(H)
1.
WhichtitleoftheProfessionalStandardsaddressesthisissue?
2.
Entertheexactsectionnumberandparagraphsthataddresscommunication
oftheseuncorrectedmisstatementstotheauditcommittee.
TaskBasedSimulation8
InternalControlRelated
MattersCommunication
Authoritative
Literature
Help
Youhavebeenaskedtotheauditpartnertodraftalettertotheclientoninternalcontrolrelatedmatters.Youwere
informedthatthewrittencommunicationregardingsignificantdeficienciesandmaterialweaknessesindentifiedduringan
auditoffinancialstatementsshouldincludecertainstatements.
Foreachofthesignificantdeficienciesandmaterialweaknessesreflectedinthetablebelow,doubleclickoneachof
theassociatedshadedcellsandselectfromthelistprovidedtheappropriatedispositionofeachstatementinregardtothe
lettertotheclientoninternalcontrolrelatedmatters.Eachselectionmaybeusedonce,morethanonce,ornotatall.
SelectionList
Included
Excluded
Included,butonlywithclientmanagementsapproval
Communicatedorallywithnoneedtodocumentthecommunication
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
90
Internalcontrols
Statethatthepurposeoftheauditwastoexpressan
opiniononthefinancialstatements,andtoexpressan
opinionontheeffectivenessoftheentitysinternal
controloverfinancialreporting.
Relatedmatters
Identify,ifapplicable,itemsthatareconsideredtobe
materialweaknesses.
Statethattheauthorisnotexpressinganopiniononthe
effectivenessofinternalcontrol.
Includethedefinitionofthetermsignificantdeficiency.
Includethedefinitionofthetermmaterialweakness,
whererelevant.
Statethattheauthorisexpressinganunqualifiedopinion
ontheeffectivenessofinternalcontrol.
Statethatthecommunicationisintendedsolelyfor
managementandexternalparties.
Identifythemattersthatareconsideredtobesignificant
deficiencies.
TaskBasedSimulation9
Research
Authoritative
Literature
Help
Integratedaudits
AssumethatyouareassignedtotheauditofRegisCorporation,anissuercompany.Yourfirmisperformingitsfirst
integratedauditforthecompany,andthepartnerontheengagementhasaskedyoutoresearchprofessionalstandardsto
identifythecontrolsthataddresstheriskoffraud.
Selections
A. AU
B. PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
(A)(B)(C)(D)(E)(F)(G)(H)
1.
WhichtitleoftheProfessionalStandardsaddressesthisissue?
2.
Entertheexactsectionandparagraphwithhelpfulinformation.
MODULE3
UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
91
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
a
d
b
b
c
__
__
__
__
__
__
__
__
__
__
35.
36.
37.
38.
39.
d
a
b
d
c
__
__
__
__
__
__
__
__
__
__
69.
70.
71.
72.
73.
c
a
d
a
a
__
__
__
__
__
__
__
__
__
__
103.
104.
105.
106.
107.
c
c
c
c
b
__
__
__
__
__
__
__
__
__
__
137.
138.
139.
140.
141.
d
b
b
b
b
__
__
__
__
__
__
__
__
__
__
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
b
d
a
d
a
d
b
a
a
b
b
b
a
a
d
b
b
c
d
d
d
c
d
d
a
c
d
d
a
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
40.
41.
42.
43.
44.
45.
46.
47.
48.
49.
50.
51.
52.
53.
54.
55.
56.
57.
58.
59.
60.
61.
62.
63.
64.
65.
66.
67.
68.
a
c
a
b
a
c
d
a
d
d
d
a
d
d
b
c
a
a
a
c
a
a
b
c
a
b
b
c
c
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
74.
75.
76.
77.
78.
79.
80.
81.
82.
83.
84.
85.
86.
87.
88.
89.
90.
91.
92.
93.
94.
95.
96.
97.
98.
99.
100.
101.
102.
c
b
a
a
c
d
b
a
a
d
c
d
b
c
b
b
d
b
d
b
b
d
d
b
b
d
c
d
d
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
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__
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__
108.
109.
110.
111.
112.
113.
114.
115.
116.
117.
118.
119.
120.
121.
122.
123.
124.
125.
126.
127.
128.
129.
130.
131.
132.
133.
134.
135.
136.
b
a
a
c
c
a
c
a
c
c
a
d
d
a
a
b
d
d
d
d
b
a
c
d
c
c
c
d
c
__
__
__
__
__
__
__
__
__
__
__
__
__
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__
__
__
__
__
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__
__
142.
143.
144.
145.
146.
147.
148.
149.
150.
151.
152.
153.
154.
155.
156.
157.
158.
159.
160.
161.
162.
163.
164.
165.
166.
b
b
b
a
a
d
a
c
d
b
b
a
d
d
c
d
b
d
a
d
a
a
a
a
d
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
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1st:__/166=__%
2nd:__/166=__%
MULTIPLECHOICEANSWEREXPLANATIONS
A.1.DefinitionofInternalControl
1.
(a)Therequirementistoidentifythereplythatmostlikely
wouldnotbeconsideredaninherentlimitationofthe
potentialeffectivenessofanentitysinternalcontrol.An
swer(a)iscorrectbecauseincompatibledutiesmaygener
allybedividedamongindividualsinsuchamannerasto
controltheproblem.Answers(b),(c),and(d)areallincor
rectbecausemanagementoverride,mistakesofjudgment,
andcollusionamongemployeesareallinherentlimitations
ofinternalcontrol.
2.
(d)Therequirementistoidentifythemeaningofthe
conceptofreasonableassurance.Answer(d)iscorrectbe
causereasonableassurancerecognizesthatthecostofinter
nalcontrolshouldnotexceedthebenefitsexpectedtobe
derived.
3.
(b)Therequirementistoidentifythefunctions
thatshouldbesegregatedforeffectiveinternal
control.Answer(b)iscorrectbecause
authorizingtransactions,recordingtransactions,
andmaintainingcustodyofassetsshouldbe
segregated.
A.2.MajorComponentsofInternalControl
4.(b)Therequirementistoidentifythemostlikelytype
ofongoingmonitoringactivity.Answer(b)iscorrect
becauseongoingmonitoringinvolvesassessingthedesign
andoperationofcontrolsonatimelybasisandtaking
necessarycorrectiveactionsandsuchanapproachmaybe
followedinreviewingthepurchasingfunction.Answer(a)
isincorrectbecauseperiodicauditsarenotordinarilyper
formedbytheauditcommittee,asubcommitteeofthe
BoardofDirectors.Answer(c)isincorrectbecausethe
auditoftheannualfinancialstatementsisnotordinarily
consideredmonitoringaspresentedintheprofessional
standards.Answer(d)isincorrectbecausethemeaningof
thereply,controlriskassessmentinconjunctionwith
quarterlyreviews,isuncertain.
5.
(c)Therequirementistoidentifywherethe
overallattitudeandawarenessofanentitysboard
ofdirectorsconcerningtheimportanceofinternal
controlisnormallyreflected.Answer(c)is
correctbecausethecontrolenvironmentreflects
theoverallattitude,awareness,andactionsofthe
boardofdirectors,management,owners,and
othersconcerningtheimportanceofcontroland
itsemphasisintheentity.
6.
(b)Therequirementistoidentifythe
circumstanceinwhichmanagementphilosophy
andoperatingstylewouldhaveasignificant
influenceonanentityscontrolenvironment.
Answer(b)iscorrectbecausemanagement
philosophyandoperatingstyle,whilealways
important,isparticu
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
92
larlysowhenmanagementisdominatedbyoneora
fewindividualsbecauseitmayimpactnumerous
otherfactors.Answer(a)isincorrectbecausethe
impactoftheinternalauditorreportingdirectlyto
managementislikelytobelessthanthatofanswer
(a).Answer(c)isincorrectbecausewhileaccurate
managementjobdescriptionsaredesirable,theydo
nothaveassignificantofaneffectonmanagement
philosophyandoperatingstyleasdoesdominationby
anindividual.Answer(d)isincorrectbecausean
activeauditcommitteemighttemperratherthanlead
toamoresignificantinfluenceofmanagement
philosophyandoperatingstyle.
7.
(d)Therequirementistodeterminewhichofthe
factorslistedareincludedinanentityscontrol
environment.Answer(d)iscorrectbecausetheaudit
committee,integrityandethicalvalues,and
organizationstructureareallincluded.
8.
(a)Therequirementistoidentifythereply
thatisnotacomponentofanentitys
internalcontrol.Answer(a)iscorrect
becausewhileauditorsassesscontrolriskas
apartoftheirconsiderationofinternal
control,itisnotacomponentofanentitys
internalcontrol.Answers(b),(c),and(d)are
incorrectbecausethecontrolenvironment,
riskassessment,controlactivities,
informationandcommunication,and
monitoringarethefivecomponentsofan
entitysinternalcontrol(SAS109).
A.3.RelatedTopics
9.(d)TheForeignCorruptPracticesActmakespay
mentofbribestoforeignofficialsillegalandrequires
publiclyheldcompaniestomaintainsystemsof
internalcontrolsufficienttoprovidereasonable
assurancesthatinternalcontrolobjectivesaremet.
B.1.ObtainUnderstandingoftheClientandIts
InternalControl
10. (a)Therequirementistodeterminethemost
likelypopulationfromwhichanauditorwould
samplewhenvendorsinvoicesandrelated
vouchersrelatingtopurchasesmadeby
employeeshavebeendestroyed.Answer(a)is
correctbecausethedisbursementwillbe
recordedandtheauditormaythussamplefrom
thatpopulation.Answers(b)and(d)are
incorrectbecausetherelatedvouchersandven
dorsinvoicesaredestroyed.Answer(c)is
incorrectbecausethereisnorecordingofthe
receiptofthemerchandise.
11. (d)Therequirementistoidentifythe
procedureanauditorwouldperformto
provideevidenceaboutwhetheranentitys
internalcontrolactivitiesaresuitably
designedtopreventordetectmaterial
misstatements.Answer(d)iscorrectbecause
SAS109indicatesanauditorwillobserve
theentityspersonnelapplyingthe
procedurestodeterminewhethercontrols
havebeenimplemented.Answer(a)is
incorrectbecausereperformingtheactivities
isatestofcontroltohelpassessthe
operatingeffectivenessofacontrol.Answer
(b)isincorrectbecauseanalyticalprocedures
arenotperformedtodeterminewhether
controlsaresuitablydesigned.Answer(c)is
incorrectbecausevouchingasampleof
transactionsisasubstantivetestnotdirectly
aimedatdeterminingwhethercontrolsare
suitablydesigned.SeeSAS109fora
discussionofanauditorsresponsibilityfor
determiningwhethercontrolshavebeen
implementedvs.theiroperating
effectiveness.
(b)Therequirementistoidentifythecorrectstate
mentrelatingtotherelevanceofvarioustypesof
controlstoafinancialstatementaudit.Answer(b)is
correctbecause,generally,controlsthatarerelevantto
anauditpertaintotheentitysobjectiveofpreparing
financialstatementsforexternalpurposes.Answer(a)
isincorrectbecauseSAS109makesclearthatan
auditormaynotignoreconsiderationofcontrolsunder
anyauditapproach.Answer(c)isincorrectbecause
controloverfinancialreportingareofprimaryim
portance.Answer(d)isincorrectbecausemany
operationalandcompliancerelatedcontrolsarenot
ordinarilyrelevanttoanaudit.
(a)Therequirementistoidentifythestatement
thatrepresentsarequirementwhenanaudit
offinancialstatementsinaccordancewith
generallyacceptedaccountingprinciplesis
performed.Answer(a)iscorrectbecause
SAS109requiresthattheauditordocument
theunderstandingoftheentitysinternal
control.Answer(b)isincorrectbecause
whileanauditormightfindsignificant
deficienciesintheoperationofinternal
control,nosuchsearchisre
quired.Answer(c)isincorrectbecauseanauditor
mightuseasubstantiveapproachinperformingan
auditandtherebyperformfew(ifany)testsof
controls.Answer(d)isincorrectbecausewhile
auditorsmustobtainknowledgeofinternalcontrol
sufficientlytoidentifytypesofpotentialmis
statements,theyarenotrequiredtoobtainthedetailed
knowledgeofinternalcontrolsuggestedbythisreply.
(a)Therequirementistoidentifytheknowledge
thatanauditormustobtainwhenobtainingan
understandingofanentitysinternalcontrol
sufficientforauditplanning.Answer(a)is
correctbecauseanauditormustobtainanun
derstandingthatincludesknowledgeaboutthe
designofrelevantcontrolsandrecordsand
whethertheclienthasplacedthosecontrolsin
operation.Answers(b)and(c)areincorrect
becauseauditorsmaychoosenottoobtain
informationonoperatingeffectivenessof
controlsandtheirconsistencyofapplication.
Answer(d)isincorrectbecausethereisno
suchexplicitrequirementrelatingtocontrols;
seeSAS109forthenecessaryunderstandingof
internalcontrol.
(b)SAS109statesthattheauditorshould
obtainsufficientknowledgeofthe
information(includingaccounting)system
tounderstandthefinancialreportingprocess
usedtopreparetheentitysfinancial
statements,includingsignificantaccounting
estimatesanddisclosures.Italsostatesthat
thisknowledgeisobtainedtohelpthe
auditortounderstand(1)theentitysclasses
oftransactions,(2)howtransactionsare
initiated,(3)theaccountingrecordsand
support,and(4)theaccountingprocessing
involvedfrominitiationofatransactionto
itsinclusioninthefinancialstatements.
(b)Therequirementistodeterminewhyan
auditorshouldconcentrateonthesubstanceof
proceduresratherthantheirformwhen
obtaininganunderstandingofanentitys
controls.Answer(b)iscorrectbecause
managementmayestablishappropriate
controlsbutnotactonthem,thuscreatinga
situationinwhichtheformdiffersfromthe
substance.Answer(a)isincorrectbecause
documentationisnotdirectlyrelatedtothe
issueofsubstanceoverform.Answer(c)is
incorrectbecauseinappropriatecontrolsis
onlyapartofanauditorconcern;forexample,
acontrolmaybeappropriate,butitmaynotbe
operatingeffectively.Answer(d)isincorrect
becausewhileanauditormightsuggest
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
to management that the cost of certain controls
seemstoexceedtheirlikelybenefit,thisisnotthe
primary reason auditors are concerned with the
substanceofcontrols.
17. (b)Decisiontablesincludevarious
combinationsofconditionsthatarematchedto
oneofseveralactions.Inaninternalcontrol
setting,thevariousimportantcontrolsare
reviewedand,basedonthecombinationof
answersreceived,anactionsuchasadecision
onwhethertoperformtestsofcontrolsis
determined.Programflowchartssimply
summarizethestepsinvolvedinaprogram.
Answer(a)isincorrectbecausedecisiontables
donotemphasizetheeaseofmanageabilityfor
complexprograms.Answer(c)isincorrect
becausewhiledecisiontablesmaybedesigned
usingvariouscostbenefitfactorsrelatingtothe
variousconditionsandactions,theydonot
justifytheprogram.Answer(d)isincorrect
becauseprogramflowcharts,notdecision
tables,emphasizethesequenceinwhich
operationsareperformed.
18. (a)Therequirementistoidentifytheprocedurethatis
notrequiredtobeincludedinanauditors
considerationofinternalcontrol.Answer(a)iscorrect
becausetheauditorneednotobtainevidencerelating
tooperatingeffectivenesswhencontrolriskistobe
assessedatthemaximumlevel.Answer(b)isincorrect
becauseanauditormustobtainanunderstandingofthe
internalcontrolenvironmentandtheinformation
system.Answers(c)and(d)areincorrectbecausean
auditorisobligatedtoobtaininformationonthedesign
ofinternalcontrolandonwhethercontrolactivities
havebeenimplemented.
19. (a)Therequirementistoidentifytheprimary
objectiveofproceduresperformedtoobtain
anunderstandingofinternalcontrol.Answer
(a)iscorrectbecausetheauditorobtainsa
sufficientunderstandingofinternalcontrolto
assesstherisksofmaterialmisstatementand
todesignthenature,timing,andextentof
furtherauditprocedures.Answer(b)
addressesinherentrisk,thesusceptibilityof
anassertiontomaterialmisstatement,
assumingthattherearenorelatedcontrols.
Answer(b)isincorrectsincetheconceptof
inherentriskassumesnointernalcontroland
isthereforenottheprimaryobjective.
Answer(c)isincorrectbecauseanswer(a)is
morecompleteandbecausedecisionson
modifyingtestsofcontrolsareoftenmadeat
alaterpointintheaudit.Answer(d)is
incorrectbecausetheconsistencyof
applicationofmanagementspoliciesrelates
moredirectlytotestsofcontrolsthanto
obtaininganunderstandingofinternal
control.
20. (d)Therequirementistodeterminethe
correctstatementwithrespecttothe
auditorsrequireddocumentationofthe
93
clientsinternalcontrol.Anauditormay
documenthis/herunderstandingofthe
structureandhis/herconclusionsaboutthe
designofthatstructureintheformof
answerstoaquestionnaire,narrative
memorandums,flowcharts,decisiontables,
oranyotherformthattheauditorconsiders
appropriateinthecircumstances.Answers
(a)and(b)are,thus,incorrectbecausethey
suggestrestrictionswhichdonotexistin
practice.Answer(c)isincorrectsinceata
minimumalistofreasonsfornonreliance
mustbeprovided.
21. (b)Inobtaininganunderstandingofinternal
control,theauditorshouldperform
procedurestoprovidesufficientknowledge
ofthedesignoftherelevantcontrolsand
whethertheyhavebeenimplemented.
Informationon
operatingeffectivenessneednotbeobtainedunless
controlriskistobeassessedatalevelbelowthe
maximum.
B.2. AssesstheRiskofMaterial
MisstatementandDesignFurtherAudit
Procedures
22. (b) Answer (b) is correct because tests of
controlsareonlyrequiredwhentheauditor
relies on the controls or substantive tests
alone are not sufficient to audit particular
assertions. Answers (a), (c), and (d) are
incorrect because these procedures are
requiredoneveryaudit.
23. (c)Therequirementistoidentifythetermsinwhich
controlriskshouldbeassessed.Answer(c)iscorrect
becauseSAS109requiresthatcontrolriskbe
assessedintermsoffinancialstatementassertions.
24. (d)Therequirementistoidentifyasituation
inwhichanauditormaydesiretoseeka
furtherreductionintheassessedlevelof
controlrisk.Answer(d)iscorrectbecause
suchareductionisonlypossiblewhen
additionalevidence,evaluatedby
performingadditionaltestsofcontrols,is
available.Answer(a)isincorrectbecause
auditorsatthispointwillordinarilyalready
haveobtainedtheunderstandingofthe
informationsystemtoplantheaudit.
Furthermore,anunderstandingofinternal
controlisneededonallaudits.Answer(b)is
incorrectbecauseauditorsmustdetermine
thatcontrolshavebeenimplementedinall
audits.Answer(c)isincorrectbecausea
significantnumberofcontrolsalways
pertaintofinancialstatementassertions.
25. (d) Assessing control risk at a low level
involves
(1)identifyingspecificcontrolsrelevanttospecific
assertions that are likely to prevent or detect
materialmisstatementsinthoseassertions,and(2)
performing tests of controls to evaluate the
effectivenessofsuchcontrols.
Answer(a)isincorrectbecauseassessingcontrolrisk
atalowlevelmayleadtolessextensive,notmore
extensivesubstantivetests.Answer(b)isincorrect
becausetheactuallevelofinherentriskisnot
affectedbythelevelofcontrolrisk.Also,onewould
notexpectachangeintheassessedlevelofcontrol
risktoresultinachangeintheassessedlevelof
inherentrisk.Answer(c)isincorrectbecauseas
sessingcontrolriskatalowlevelmayleadtointerim
datesubstantivetestingratherthanyearendtesting.
26. (d)Therequirementistodeterminewhyan
auditorassessescontrolrisk.Answer(d)is
correctbecausetheassessedlevelsof
controlriskandinherentriskareusedto
determinetheacceptablelevelofdetection
riskforfinancialstatementassertions.
27. (c)Increasesintheassessedleveloftherisk
ofmaterialmisstatementleadtodecreasesin
theacceptablelevelofdetectionrisk.
Accordingly,theauditorwillneedto
increasetheextentofsubstantivetestssuch
astestsofdetails.Answer(a)isincorrect
becausetestsofcontrolsareperformedto
reducetheassessedlevelofcontrolriskonly
whencontrolsarebelievedtobeeffective.
Answer(b)isincorrectbecausethelevelof
detectionriskmustbedecreased,not
increased.Answer(d)isincorrectbecause
thelevelofinherentriskpertainstothe
susceptibilityofanaccounttomaterial
misstatementindependentofrelated
controls.
28. (d)Therequirementistodeterminethe
primarypurposeforwhichanauditoruses
theknowledgeprovidedbytheunderstanding
ofinternalcontrolandtheassessed
94
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
leveloftheriskofmaterialmisstatement.Answer(d)
iscorrectbecausetheauditorusessuchknowledgein
determiningthenature,timing,andextentof
substantivetestsforfinancialstatementassertions.
Answer(a)isincorrectbecauseitisincomplete.For
example,whileauditorsareconcernedwiththe
safeguardingofassets,theyalsoneedtodetermine
whetherthefinancialstatementinformationis
accurate.Answer(b)isincorrectforreasonssimilar
to(a)inthatdeterminingwhetheropportunitiesare
availableforcommittingandconcealingfraudis
incompletesincethisknowledgeisalsousedto
ascertainwhetherthechanceoferrorsisminimized.
Answer(c)isincorrectbecauseknowledgeprovided
bytheunderstandingofinternalcontrolandthe
assessedlevelofcontrolriskisnotusedtomodify
initialassessmentsofinherentriskandpreliminary
judgmentsaboutmaterialitylevels.Thisknowledgeis
unrelatedtothoseprocesses.
29. (d)Therequirementistoidentifyawaythatanauditor
maycompensateforaweaknessininternalcontrol.
Answer(d)iscorrectbecauseincreasinganalytical
proceduresdecreasesdetectionriskinamanner
whichmaycounterbalancetheconditionininternal
control.Ineffect,theweaknessininternalcontrolis
compensatedforbyincreasedsubstantivetesting.See
theoutlineofSAS107fortherelationshipsamong
auditriskanditscomponentrisksinherentrisk,
controlrisk,anddetectionrisk.Answer(a)isincorrect
becauseincreasingbothcontrolrisk(througha
weaknessininternalcontrol)anddetectionrisk
increasesauditrisks.Inaddition,controlriskand
detectionriskdonotcompensateforoneanother.
Answer(b)isincorrectbecauseincreasingtheextent
oftestsofcontrolsisunlikelytobeeffectivesincethe
conditionisknowntoexist.Answer(c)isincorrect
becauseitisnotgenerallyappropriatetoincreasethe
judgmentastoauditriskbasedontheresultsobtained.
30. (a)Therequirementistoidentifythecorrectstatement
concerninganauditorsassessmentofcontrolrisk.
Answer(a)iscorrectbecauseSAS109indicatesthat
assessingcontrolriskmaybeperformedconcurrently
duringanauditwithobtaininganunderstandingof
internalcontrol.Answer(b)isincorrectbecause
evidenceabouttheoperationofinternalcontrol
obtainedinpriorauditsmaybeconsideredduringthe
currentyearsassessmentofcontrolrisk.Answer(c)is
incorrectbecausethebasisforanauditorsconclusions
abouttheassessedlevelofcontrolriskneedstobe
documentedwhencontrolriskisassessedat
levelsotherthanthemaximumlevel.Answer(d)is
incorrectbecausealowerlevelofcontrolrisk
requiresmoreassurancethatthecontrolprocedures
areoperatingeffectively.
31.(c)Therequirementistodeterminethe
correctstatementconcerningtheassessedlevelof
controlrisk.Answer(c)iscorrectbecauseordinarily
theassessedlevelofcontrolriskcannotbe
sufficientlylowtoeliminatetheneedtoperformany
substantiveteststorestrictdetectionriskfor
significanttransactionclasses.Answer(a)isincorrect
becausetestsofcontrolsareunnecessarywhen
controlriskisassessedatthemaximumlevel.Answer
(b)isincorrectbecauseanalyticalproceduresarenot
designedtoverifythedesignofinternalcontrol.
Answer(d)isincorrectbecausedualpurposetests
(i.e.,thosethatserveasbothsubstantivetestsandtests
ofcontrols)arenotrequiredtobeperformed,and
becausethetermpreliminarycontrolriskisunclear.
B.3.PerformFurtherAuditProceduresTestsof
Controls
32. (d)Therequirementistoidentifyhow
frequentlycontrolsthattheauditorwishesto
relyuponmustbetested.Answer(d)is
correctbecausetheprofessionalstandards
requireauditorstotestcontrolsatleastevery
thirdyear.Answer(a)isincorrectbecause
controlsneednotbetestedmonthly.Answer
(b)isincorrectbecauseordinarilycontrols
neednotbetestedwitheachaudit.Answer
(c)isincorrectbecauseauditorsmaytest
suchcontrolseverythirdyear,notevery
secondyear.
33. (d)Therequirementistoidentifythetypeof
audittestmostlikelytoprovideassurance
thatcontrolsareinuseandoperating
effectively.Answer(d)iscorrectbecause
inspectionofdocumentsisaformofatestof
controls,andsuchtestsareusedtoobtain
reasonableassurancethatcontrolsareinuse
andoperatingeffectively.Answer(a)isin
correctbecauseauditorsprepareflowcharts
todocumentacompanysinternalcontrol,
nottoobtainassurancethatcontrolsarein
useandoperatingeffectively.Answer(b)is
incorrectbecausesubstantivetestsrelateto
theaccuracyofaccountsandassertions
ratherthantestingcontrolsdirectly.Answer
(c)isincorrectbecauseanalyzingtestsof
trendsandratiosisananalyticalprocedure
thatdoesnotdirectlytestcontrols.
34. (a)Therequirementistoidentifythe
appropriateproceduresfortestingthe
segregationofdutiesrelatedtoinventory.
Answer(a)iscorrectbecauseSAS109
suggeststhatwhennoaudittrailexists(as
isoftenthecaseforthesegregationof
duties)anauditorshouldusethe
observationandinquirytechniques.
35. (d)Therequirementistoidentifytheobjectiveoftests
ofdetailsoftransactionsperformedastestsof
controls.Answer(d)iscorrectbecausethepurposeof
testsofcontrolsistoevaluatewhetherinternalcontrol
operateseffectively.Answer(a)isincorrectbecause
whilemonitoringthedesignanduseofentity
documentsmaybeviewedasatestofcontrols,itis
nottheobjective.Answer(b)isincorrectbecause
determiningwhetherinternalcontrolisimplementedis
notdirectlyrelatedtotestsofcontrols;seeSAS109
forthedistinctionbetweenimplementedand
operatingeffectiveness.Answer(c)isincorrect
becausesubstantivetests,nottestsofcontrols,are
focusedondetectionofmaterialmisstatementsinthe
accountbalancesofthefinancialstatements.
36. (a)Therequirementistoidentifya
circumstanceinwhichanauditormay
decidetoperformtestsofcontrols.Answer
(a)iscorrectbecausetestsofcontrolswill
beperformedwhentheyareexpectedto
resultinacosteffectivereductioninplanned
substantivetests.Answer(b)isincorrect
becausetestsofcontrolsareonlyperformed
whentheyarelikelytosupportafurther
reductionintheassessedleveloftheriskof
materialmisstatement.Answer(c)is
incorrectbecausetestsofcontrolsare
designedtodecreasetheassessedlevelof
theriskofmaterialmisstatement,not
increaseit.Answer(d)isincorrectbecause
internalcontrolweaknessesnormallyresult
inmoresubstantivetestingandlesstestsof
controls.
37. (b)Therequirementistoidentifythemost
appropriateproceduresforassessingcontrol
risk.Auditorsperformtestsofcontrolsto
obtainevidenceontheoperatingeffec
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
tivenessofcontrolstoassesscontrolrisk.Answer(b)
iscorrectbecausetestsofcontrolsincludeinquiriesof
appropriateentitypersonnel,inspectionofdocuments
andreports,observationoftheapplicationofthe
policyorprocedure,andreperformanceofthe
applicationofthepolicyorprocedure.
38. (d)Therequirementistoidentifythetypeofevidence
anauditormostlikelywouldexaminetodetermine
whethercontrolsareoperatingasdesigned.Answer(d)
iscorrectbecauseinspectionofclientrecords
documentingtheuseofcomputerprogramswill
provideevidencetohelptheauditorevaluatethe
effectivenessofthedesignandoperationofinternal
control;theclientscontroloveruseofitscomputer
programsinthiscaseisdocumentationoftheuseof
theprograms.Inordertotestthiscontrol,theauditor
willinspectthedocumentationrecords.SeeSAS110
forinformationonthenatureoftestsofcontrols.
Answer(a)isincorrectbecausetheconfirmation
processismostfrequentlyconsideredasubstantive
test,notatestofacontrol.Answer(b)isincorrect
becauselettersofrepresentationsprovide
corroboratinginformationonvariousmanagementrep
resentationsobtainedthroughouttheauditand
thereforeonlyprovideslimitedevidenceoninternal
control.Answer(c)isincorrectbecauseattorneys
responsestoauditorinquiriesmostfrequentlypertain
tolitigation,claims,andassessments.
39. (c)Therequirementistoidentifythe
procedurethatisnotastepinanauditors
assessmentofcontrolrisk.Answer(c)is
correctbecauseperformingtestsofdetailsof
transactionstodetectmaterialmisstatements
pertainsmoredirectlytodetectionriskrather
thaninherentorcontrolrisk.Answer(a)is
incorrectbecauseauditorsevaluatetheeffec
tivenessofinternalcontrolwithtestsof
controls.An
swer(b)isincorrectbecauseobtainingan
understandingoftheentitysinformationsystemand
controlenvironmentisapreliminarystepfor
consideringcontrolrisk.Answer(d)isincorrect
becauseauditorswillconsidertheeffectofinternal
controlonthevariousfinancialstatementassertions.
40. (a)Therequirementistoidentifyan
approachthatauditorsusetoobtainaudit
evidenceaboutcontrolrisk.Answer(a)is
correctbecauseauditorstestcontrolstopro
videevidencefortheirassessmentofcontrol
riskthroughinquiriesofappropriate
personnel,inspectionofdocumentsand
records,observationoftheapplicationof
controls,andreperformanceofthe
applicationofthepolicyorprocedure.
Answers(b),(c),and(d)areincorrect
becauseanalyticalprocedures,calculation,
andconfirmationrelatemoredirectlyto
substantivetestingandarenotprimary
methodstotestcontrolsforpurposesof
assessingcontrolrisk.
41. (c)Therequirementistoidentifytheleast
likelytypeofevidencetheauditorwill
examinetodeterminewhethercontrolsare
95
operatingeffectively.Answer(c)iscorrect
becauseconfirmationofaccountsreceivable
isasubstantivetest,notatestofacontrol.
Answer(a)isincorrectbecauserecords
documentingtheusageofcomputer
programsmaybetestedtodetermine
whetheraccessisappropriatelycontrolled.
Answer(b)isincorrectbecauseexamining
canceledsupportingdocumentsmayhelp
theauditortodeterminethatthestructure
willnotallowduplicatebillingtoresultin
multiplepayments.Answer(d)isincorrect
becausepropersignatureswillhelpthe
auditortodeterminewhetherthe
authorizationcontrolsarefunctioning
adequately.
42.(a)Therequirementistoidentifytheaccountsre
ceivableauditingprocedurethatanauditorwouldmost
likelyperformtoobtainsupportforanassessedlevel
ofcontrolriskbelowthemaximum.Sinceanauditor
usestheresultsoftestsofcontrolstosupportan
assessedlevelofcontrolriskbelowthemaximum,we
areattemptingtoidentifyatestofacontrol.Answer
(a)iscorrectbecauseobservinganentitysemployee
preparethescheduleofpastdueaccountsreceivableis
atestofacontroltoevaluatetheeffectivenessthe
processofpreparinganaccuratescheduleofpastdue
accounts;iftheprocessisfoundtobeeffectiveitmay
leadtoareductionintheassessedlevelofcontrolrisk.
Answer(b)isincorrectbecausetheconfirmationof
accountsreceivableisasubstantivetest,notatestofa
control.Answer(c)isincorrectbecausetheinspection
ofaccountsreceivableforunusualbalancesand
comparinguncollectibleaccountsexpensetoactual
accountsexpenseisordinarilyananalyticalprocedure
performedasasubstantivetest.Answer(d)is
incorrectbecausecomparinguncollectibleaccounts
expensetoactualuncollectibleaccountsisordinarilya
substantivetest.
C.1.ManagementsResponsibility
43. (b)Therequirementistoidentifythetypeof
companiestowhichtheinternalcontrolprovisionsof
theSarbanesOxleyActof2002apply.Answer(b)is
correctbecausetheprovisionsapplytopublic
companiesthatareregisteredwiththeSecuritiesand
ExchangeCommission.Answer(a)isincorrect
becausenonissuercompaniesarenotdirectlyaffected
bythecontrolprovisions.Answer(c)isincorrect;
thereisno$100,000,000requirement.Answer(d)is
incorrectbecausenonissuercompaniesarenotdirectly
affectedbytheinternalcontrolprovisionsoftheAct.
44. (a)Therequirementistoidentifythemost
likelyframeworktobeusedbymanagementin
itsinternalcontrolassessment.Answer(a)is
correctastheCOSOinternalcontrol
frameworkisbyfarthemostfrequentlyused
one.Answer(b)isincorrectbecausewhilea
COSOenterpriseriskmanagementframework
doesexist,itisnotordinarilyusedby
managementinitsinternalcontrolassessment.
Answers(c)and(d)areincorrectbecause
thereisnosuchthingasaFASB37internal
controldefinitionalframeworkoranAICPA
internalcontrolanalysismanager.
C.2.ManagementsAssessment
45. (c)Therequirementistoidentifythecorrect
statementconcerningthelevelofassistance
thatauditorsmayprovideinassisting
managementwithitsassessmentofinternal
control.Answer(c)iscorrectsinceonly
limitedassistancemaybeprovidedsoas
nottocreateasituationinwhichthe
auditorsareauditingtheirownwork.
Answer(a)isincorrectsincesome
assistancemaybeprovided.Answer(b)is
incorrectbecausetherearelimitationson
thelevelofassistance.Answer(d)is
incorrectbecausethetiebetweenriskand
assistanceseemsinappropriateandinthe
wrongdirection;also,thistypeoftradeoff
betweenriskandassistanceisnotincluded
inPCAOBStandard5.
46. (d)Therequirementistoidentifywhichof
thefollowingneednotbeincludedin
managementsreportoninternalcontrol
underSection404aoftheSarbanesOxley
Actof2002.Answer(d)iscorrectbecause,
whilethereportmustindicatethatitis
managementsresponsibilitytoestablish
andmaintainadequateinternalcontrol,it
neednot
96
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
alsoindicatethatsuchcontrolhasnosignificant
deficiencies.Answers(a),(b),and(c)areallincorrect
becausetheyincludeinformationthatmustbe
containedinmanagementsreport.
C.3.ControlDefinitions
47. (a)Answer(a)iscorrectbecauseallmaterial
weaknessesarecontroldeficiencies.Answer
(b)isincorrectbecauseasignificant
deficiencymayormaynotbeamaterial
weakness.Answer(c)isincorrectbecause
notallcontroldeficienciesarematerial
weaknesses.Answer(d)isincorrectbecause
onlysignificantdeficienciesandmaterial
weaknessesmustbecommunicated.
48. (d)Therequirementistoidentifytheterm
thatisdefinedasaweaknessininternal
controlthatislessseverethanamaterial
weaknessbutimportantenoughtowarrant
attentionbythoseresponsibleforoversight
ofthefinancialreportingfunction.Answer
(d)iscorrectbecausethisisthedefinitionof
asignificantdeficiency.Answer(a)isincor
rectbecauseacontroldeficiencyexists
whenthedesignoroperationofacontrol
doesnotallowmanagement,oremployees,
inthenormalcourseofperformingtheir
functionstopreventordetectmisstatements
onatimelybasis.Answer(b)isincorrect
becauseanunusualweaknessisnotusedin
thestandardsforintegratedaudits.Answer
(c)isincorrectbecausethetermunusual
deficiencyisnotusedinthestandardsfor
integratedaudits.
49. (d)Therequirementistoidentifythe
amountinvolvedwithamaterialweakness.
Answer(d)iscorrectbecauseamaterial
amountisinvolved.Answers(a),(b),and
(c) are all incorrect because they suggest smaller
amounts.
50. (d)Therequirementistoidentifytheminimum
likelihoodoflossinvolvedintheconsiderationofa
controldeficiency.Answer(d)iscorrectbecausea
controldeficiencyisaconditioninwhichthe
operationofacontroldoesnotallowmanagement,or
employees,inthenormalcourseofperformingtheir
functionstopreventordetectmisstatementsona
timelybasisitdoesnotexplicitlyconsiderlikelihood
ofloss.Answer(a)isincorrectbecausetheminimum
likelihoodoflossisnotconsidered.Answer(b)is
incorrectbecausethecontroldeficiencyoccurrenceof
lossneednotbemorethanremote.Answer(c)is
incorrectbecausewhethertheminimumlikelihoodof
lossisprobableisnotconsidered.
C.4.EvaluatingInternalControl
51. (a)Therequirementistoidentifythetypeofcontrol
thatreconciliationofcashaccountsrepresents.Answer
(a)iscorrectinthatitisacompensatingcontrolwhich
supplementsabasicunderlyingcontrol,inthiscase
basicinformationprocessingcontrolsrelatedtocash.
Answer(b)isincorrectbecauseapreventivecontrol
preventserrorsorfraudfromoccurring.Answer(c)is
incorrectbecausethetermadjustivecontrolisnot
ordinarilyused.Answer(d)isincorrectbecause
nonroutineisordinarilyconsideredatypeof
transaction(e.g.,theyearendcloseprocess),nota
typeofcontrol.
52. (d)Therequirementistoidentifythetype
oftransactionthatestablishingloanloss
reservesis.Answer(d)iscorrectbecause
estimationtransactionsareactivities
involvingmanagementsjudgmentsor
assumptions,suchasdeterminingthe
allowancefordoubtfulaccounts,
establishingwarrantyreserves,andassessingassets
forimpairment.Answer(a)isincorrectbecausethe
termsubstantivetransactionisnotusedinPCAOB
standards.Answer(b)isincorrectbecauseroutine
transactionsarethoseforrecurringactivities,suchas
sales,purchases,cashreceiptsanddisbursements,and
payroll.Answer(c)isincorrectbecausenonroutine
transactionsoccuronlyperiodically,suchasthetaking
ofphysicalinventory,calculatingdepreciation
expense,oradjustingforforeigncurrencies;non
routinetransactionsgenerallyarenotapartofthe
routineflowoftransactions.
C.5.TheAuditofInternalControl
53. (d)Therequirementistoidentifythe
procedurethatinvolvestracingatransaction
fromoriginationthroughthecompanys
informationsystemsuntilitisreflectedinthe
companysfinancialreport.Answer(d)is
correctbecausethisistheapproachfollowed
inawalkthrough.Answer(a)isincorrect
becauseanalyticalanalysisisageneralterm
thatsimplysuggestsageneralanalysis.
Answer(b)isincorrectbecauseasubstantive
procedureaddressesthecorrectnessofa
particularfinancialstatementamountor
disclosure.Answer(c)isincorrectbecausea
testofacontroladdressestheoperating
effectivenessofacontrol.
54. (b)Therequirementistoidentifytheasof
dateforpurposesofanauditofinternal
controlperformedunderPCAOBstandards.
Answer(b)iscorrectbecausetheasof
dateisthelastdayofthefiscalperiod;itis
thisdateonwhichtheauditorconcludesas
totheeffectivenessofinternalcontrol.
Answers(a)and(c)areincorrectbecause
neitherthefirstdayoftheyearnorthelast
dayoftheauditorsfieldworkisthe
appropriatedateonwhichtoevaluateinter
nalcontrol.Answer(d)isincorrectbecause
theasofdateisaparticulardate,notan
average.
55. (c)Therequirementistoidentifythecorrectstate
mentconcerningacompanythatmakespurchases
boththroughtheInternetandbytelephone.Answer(c)
iscorrectbecausebothtypesofpurchasesareapartof
thepurchasesprocessandrepresentmajorclassesof
transactions,asperPCAOBStandard5.Answer(a)is
incorrectbecausethepurchasetypesthemselvesare
notcontrolobjectivesforinternalcontrol(control
objectivesaddressissuessuchasthecompletenessof
therecordingofsales).Answer(b)isincorrect
becausepurchasesarenotassertions.Answer(d)is
incorrectbecausepurchasetransactionsmayormay
notbeinvestigatedinextremedetail.
56. (a)Therequirementistoidentifythecircum
stance(s)inwhichwalkthroughsprovidethe
auditorwithprimaryevidence.Awalk
throughinvolvesliterallytracinga
transactionfromitsoriginationthroughthe
companysinformationsystemsuntilitis
reflectedinthefinancialreports.Answer(a)
iscorrectbecauseawalkthroughprovides
evidenceto(1)confirmtheauditors
understandingoftheflowoftransactionsand
thedesignofcontrols,(2)evaluatethe
effectivenessofthedesignofcontrols,and
(3)toconfirmwhethercontrolshavebeen
placedinoperation.Answer(b)isincorrect
becausewalkthroughsprovidetheauditors
withprimaryevidencetoconfirmwhether
controlshavebeenplacedinoperation.
Answer(c)isincorrectbecausewalk
throughsprovideprimaryevidenceto
evaluatetheeffectivenessofdesignin
internalcontrol.Answer(d)isincorrectboth
becausewalkthroughsprovideprimaryevi
denceto(1)evaluatetheeffectivenessofthe
designofcon
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
trolsand(2)confirmwhetherthecontrolshavebeen
placedinoperation.
57. (a)Therequirementistoidentifythemostlikely
questiontobeaskedofemployeepersonnelduringa
walkthrough.Answer(a)iscorrectbecauseaquestion
onwhetheranemployeehaseverbeenaskedto
overridetheprocessisincludedintheexample
questionstobeaskedbytheauditor.Answer(b)is
incorrectbecauseauditorsdonotingeneralask
whethertheemployeebelievesheorsheisunderpaid.
Answer(c)isincorrectbecauseadirectquestionon
fraudulenttransactionslikethis,whilepossible,
ordinarilyisnotsuggested.Answer(d)isincorrect
becausetheauditorwillnotusuallyaskwhotrained
theperson.Notethatallfourquestionsmightbeasked,
butonlyoneisamongthoserecommendedinStandard
5.
58. (a)Therequirementistoidentifyhowlarge
theactuallossidentifiedmustbefora
controldeficiencytopossiblybeconsidered
amaterialweakness.Answer(a)iscorrect
becauseamaterialweaknessisdetermined
bywhetherthereismorethanaremote
likelihoodofamateriallossoccurringdue
tothecontroldeficiency;theactualloss
identifiedneednotbematerial.Answer(b)
isincorrectbecauseitsuggeststhata
materialamountidentifiedwillnotbecon
sideredamaterialweakness.Answer(c)is
incorrectbecauseitstatesthatwhenthe
identifiedamountisimmaterialitisnevera
materialweakness.Answer(d)isincorrect
becauseitsuggeststhatwhenanimmaterial
ormaterialactuallossisdiscovered,the
situationwouldnotbeassessedasapossible
materialweakness.
59. (c)Therequirementistoidentifythe
circumstancethatmakesanaccount
significantforpurposesofaPCAOBauditof
internalcontrol.Answer(c)iscorrect
becauseStandard5requiresonlymorethana
remotelikelihoodofmaterialmisstatement.
Answer(a)isincorrectbecausethestandard
requiresonlyaremotelikelihoodand
becauseitislimitedtomaterial
misstatements.Answer(b)isincorrect
becausethestandardrequiresmorethana
remotelikelihood,notmorethana
reasonablypossiblelikelihood.Answer(d)is
incorrectbecausematerialmisstatementsare
involved,notmisstatementsthataremore
thaninconsequential.
60. (a)Therequirementistoidentifytheappropriate
reportwhenacontroldeficiencythatismorethana
significantdeficiencyisidentified.Answer(a)is
correctbecauseacontroldeficiencythatismorethana
significantdeficiencyisamaterialweakness,and
becauseamaterialweaknessleadstoanadverse
opiniononinternalcontrol.Answer(b)isincorrect
becausequalifiedopinionsarenotissuedwhena
materialweaknessexists.Answer(c)isincorrect
becauseanunqualifiedopinionisnotissuedwhena
97
materialweaknessexists.Answer(d)isincorrect
becauseexplanatorylanguageaddedtoanunqualified
reportisnotappropriatewhenamaterialweakness
exists.
61. (a)Therequirementistoidentifythe
deficiencythatismostlikelytobe
consideredamaterialweaknessininternal
controlforpurposesofaninternalcontrol
auditofapubliccompany.Answer(a)is
correctbecauseineffectiveoversightof
financialreportingbytheauditcommitteeis
amongthelistofcircumstancesthatPCAOB
Standard5suggestsarestrongindicatorsof
theexistenceofamaterialweakness.
Restatementofpreviouslyissuedfinancial
statementsasaresultofachangein
accountingprinciplesis
ordinarilynotconsideredevenasignificantdeficiency.
Answer(c)isincorrectbecausethereplyinadequate
segregationofrecordkeepingfromaccountingmakes
norealsensebecauseaccountingisinvolvedwith
recordkeeping.Answer(d)isincorrectbecausecontrol
activityweaknessesoftendonotrepresentmaterial
weaknesses.
end,butbeforetheauditreportisissued.
Answer(a)iscorrectbecausePCAOB
Standard5requiresanadverseauditreport
whenamaterialweaknessexistsatyear
end,theasofdate.Answer(b)isincorrect
becauseanunqualifiedopinionisnot
appropriate.Answer(c)isincorrectbecause
anunqualifiedopinionwithexplanatory
languageisnotadequate.Answer(d)is
incorrectbecauseaqualifiedopinionisnot
appropriatewhenamaterialweakness
existsatyearend.
62. (b)Therequirementistoidentifythemostappropri
atereportwhenacircumstancecausedscope
limitationresultsininabilitytoevaluateinternal
controlforasignificantaccountinvolvedintheaudit.
65. (b)Therequirementistospecifywhethermaterial
Answer(b)iscorrectbecausePCAOBStandard5
weaknessesand/orsignificantdeficienciesleadtoan
indicatesthateitheraqualifiedopinionoradisclaimer
adverseopiniononinternalcontrolinanintegratedaudit.
isappropriate,andbecausethedisclaimerisnotlisted
An
asanoption.Answer(a)isincorrectbecausean
adverseopinionisnotappropriate.Answer(c)is
swer(b)iscorrectbecauseonlymaterialweaknesses
leadtoanadverseopinion.Answer(a)isincorrect
incorrectbecauseanunqualifiedopinionwith
becausesignificantdeficienciesdonotresultinan
explanatorylanguageisnotappropriatewhenthe
adverseopinion.Answer(c)isincorrectbecause
auditorisunabletoevaluateinternalcontrolfora
materialweaknessesdoresultinadverseopinionsbut
significantaccount.Answer(d)isincorrectbecause
significantdeficienciesdonot.Answer(d)isincorrect
answers(a)and(c)arenotappropriate.
becausematerialweaknessesdoresultinadverse
63. (c)Therequirementistoidentifythemost
opinions.
likelysignificantdeficiencyrelatingtoa
66. (b)Therequirementistospecifywhattypes
clientsantifraudprograms.Answer(c)is
ofdeficienciesmustbecommunicatedby
correctbecauseanactiveauditcommittee,
theauditortotheauditcommittee.Answer
notapassiveauditcommitteeisneeded.
(b)iscorrectbecausetheauditormust
Answer(a)isincorrectbecauseabroad
communicatematerialweaknessesandother
scopeofinternalauditactivitiesisordinarily
significantdeficiencies,butnotallcontrol
astrength,notadeficiency.Answer(b)isin
deficiencies.Answer(a)isincorrectbecause
correctbecauseawhistleblowerprogram
controldeficienciesthatarenotsignificant
thatencouragesanonymoussubmissionsis
neednotbecommunicatedtotheaudit
required.Answer(d)isincorrectbecauseitis
committee(unlesstheauditorhasmadean
notordinarilynecessarytoperformcriminal
agreementtocommunicatethem).Answers
backgroundinvestigationsforlikely
(c)and(d)areincorrectbecauseknown
customers.
materialweaknessesmustbecommunicated
64. (a)Therequirementistoidentifythe
totheauditcommitteeandcontrol
appropriateauditreportwhenamaterial
deficienciesthatarenotsignificant
weaknessiscorrectedsubsequenttoyear
deficienciesneednotbecommunicated.
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MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
67. (c)Therequirementistodeterminethemannerin
whichsignificantdeficienciesarecommunicatedby
theauditortotheauditcommitteeunderPCAOB
Standard5.Answer(c)iscorrectbecausetheStandard
requiresawrittencommunication.Answer(a)is
incorrectbecauseawrittencommunicationisrequired.
Answer(b)isincorrectbecausethecommunication
mustbeinawrittenform,notinanoralform.Answer
(d)isincorrectbecausebothmaterialweaknessesand
significantdeficienciesmustbecommunicated.
68. (c)Therequirementistoidentifythecorrect
statementconcerningtheexternalauditors
useoftheworkofotherswhenperforming
anauditofinternalcontrolofapublic
company.Answer(c)iscorrectbecause,
afterassuringthemselvesastothe
competenceandobjectivityoftheinternal
auditorsandothers,theexternalauditors
mayusetheirworkparticularlyinlowrisk
areasandwhenthatworkissupervised
and/orreviewed.Answer(a)isincorrect
becauseusingtheworkofinternalauditors
andothersisallowed.Answer(b)is
incorrectbecausethereisnosuch
requirementofreportingtotheaudit
committee,althoughthisisoneindicationof
internalauditorobjective.Answer(d)is
incorrectbecausetherearelimitations,and
becauseitisuncertainwhetherliabilitywill
beshared.
69. (c)Therequirementistoidentifythe
informationthatmustbecommunicatedin
writingtomanagement.Answer(c)is
correctbecauseinanintegratedauditall
materialweaknesses,significant
deficiencies,andothercontroldeficiencies
mustbereportedtomanagement.Answers
(a)and
(b)areincorrectbecausetheyareincomplete.Answer
(d) is incorrect because all suspected and possible
employeelawviolationsneednotbecommunicated.
70. (a)Therequirementistoidentifyacorrectstatement
aboutapplyingatopdownapproachtoidentifycon
trolstotestinanintegratedaudit.Answer(a)iscorrect
becausecertaineffectiveentitylevelcontrolsmay
allowtheauditortoomitadditionaltestingbeyond
thosecontrols.Answer(b)isincorrectbecausestarting
withassertionsdoesnotrepresentstartingatthetop
(startingatthetopincludesconsiderationofthe
financialstatementsandentitylevelcontrolsfirst).
Answer(c)isincorrectbecauseconsiderationof
entitylevelcontrolscannotbeavoided.Answer(d)is
incorrectbecausenotallcontrolsrelatedtoassertions
needtobefocusedupon,andbecauseonemaynot
omitcontrolsrelatedtothefinancialstatements.
71. (d)Therequirementistoidentifythe
statementnotincludedinastandard
unqualifiedopiniononinternalcontrol
performedunderPCAOBrequirements.
Answer(d)iscorrectbecausethereport
indicatesthatmanagementisresponsible
formaintainingeffectiveinternalcontrol
overfinancialreporting,notmanagement
andtheauditcommittee.Answers(a),(b)
and(c)areallincorrectbecausethey
representstatementsincludedintheaudit
report.
72. (a)Therequirementistoidentifythecorrect
statementrelatingtowalkthroughs.
Answer(a)iscorrectbecausewalk
throughsliterallytracingtransactionsfrom
theiroriginationthroughthecompanys
informationsystemuntiltheyarereflected
inthecompanysfinancialreportsare
ofteneffectiveproceduresforevaluating
boththedesigneffectivenessofcontrolsand
whetherthosecontrolshavebeenplacedin
operation.Answer(b)isincorrectbecause
walkthroughshelpauditorstoconfirm
whethercontrolshavebeenplacedin
operation.Answer(c)isincorrect
becausewalkthroughshelpauditorstoevaluatethe
designeffectivenessofcontrols.Answer(d)is
incorrectbecausewalkthroughshelpauditors
evaluatethedesigneffectivenessofcontrolsandto
confirmwhethercontrolshavebeenplacedin
operation.
D.1.Sales,Receivables,andCashReceipts
73. (a)Therequirementistoidentifytheprocedurean
auditormostlikelywouldperformtotestcontrolsrelating
tomanagementsassertionaboutthecompletenessof
cashreceiptsforcashsalesataretailoutlet.Answer(a)is
correctbecausetheuseofcashregistersandtapeshelps
assurethatallsuchsalesarerecorded.Answer(b)is
incorrectbecausethecashhasalreadybeenrecorded.
Answer(c)isincorrectbecausetheprocedureonlydeals
withrecordeddeposits,andthereforethecompleteness
assertionisnotaddressedasdirectlyasinanswer(a).
Answer(d)isincorrectbecauseonewouldnotexpectthe
cashbalanceinthegeneralledgertoagreewiththebank
confirmationrequestamountduetoitemsintransitand
outstandingatthepointofreconciliation.
74. (c)Therequirementistoidentifytheproper
proceduretobeperformedimmediatelyupon
receiptofchecksbymail.Soundinternal
controlrequirestheuseofadequate
documentationtoensurethatalltransactions
areproperlyrecorded.Thishelpsthecompany
attainthefinancialstatementassertionof
completeness.Answer(c)iscorrectbecause
thepreparationofaduplicatelistingofchecks
receivedprovidesthecompanywithasource
documentofallthechecksreceivedthatday.
Onelististhenforwardedtotheemployee
responsiblefordepositingthechecksattheend
ofthedayandtheotherlistissenttothe
accountingdepartmentsothattheycanpostthe
amounttothecashreceiptsjournal.Answer
(a)isincorrectbecausethedailycashsummary
willordinarilybepreparedattheendoftheday
whenallcheckshavebeenreceived.Answer
(b)isincorrectbecausechecksneednotbe
comparedtoasalesinvoice.Answer(d)is
incorrectbecausetheemployeeopeningthe
mailshouldnotalsoperformtherecordkeeping
functionofrecordingthechecksinthecash
receiptsjournal.
75. (b)Therequirementistodeterminethetypeofevi
denceobtainedwhentracingshippingdocumentsto
prenumberedsalesinvoices.Answer(b)iscorrect
becausetheshippingdocumentsrelatetoshipmentsto
customers,andtracingthemtosalesinvoiceswill
provideevidenceonwhethersalesinvoiceswere
prepared.Answer(a)isincorrectbecauseduplicate
shipmentsorbillingswillnotingeneralbedetected
bytracingindividualshippingdocumentsto
prenumberedsalesinvoices.Answer(c)isincorrect
becauseanauditorwilltracefromcustomerordersto
shippingdocumentstodeterminewhetherallgoods
orderedwereshipped.Answer(d)isincorrectbecause
anauditorwillaccountforthesequenceofsales
invoicestodeterminewhetherallsaleinvoiceswere
accountedfor.
76. (a)Therequirementistoidentifythecontrol
mostlikelytoreducetheriskofdiversionof
customerreceiptsbyanentitysemployees.
Answer(a)iscorrectbecauseabanklockbox
systemeliminatesemployeecontactwith
cashreceipts,andtherebygreatlyreduces
theriskofdiversionbyemployees.Answer
(b)isincorrectbecauseremittanceadvices
areordinarilyprenumberedusingthe
numberingschemesofthevariouscustomers
andnotoftheclient;also,evenifa
prenumberingsystemisinstituted,
difficultiesremaininassuringthatall
receiptsarerecorded.Answer(c)is
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
incorrectbecauseamonthlybankreconciliationis
onlylikelytobeeffectivewhenreceiptsaredeposited
andthenabstracted.Answer(d)isincorrectbecause
whilethedailydepositofcashreceiptsmayreduce
theriskofemployeediversionofreceipts,the
procedureisnotaseffectiveasthebanklockbox
system,whicheliminatesemployeecontactwiththe
receipts.
77. (a)Therequirementistoidentifythebestlisted
procedurefordetectingthelappingofcashreceiptsby
theclientscashierthroughuseofcustomerchecks
receivedinthemail.Answer(a)iscorrectbecause
lappingwillresultinadelayintherecordingof
specificremittancecreditsonthefinancialrecords,but
thecheckswillbedepositedinthebankastheyare
received.Answer(b)isincorrectbecausethedaily
cashsummarieswillincludethesamesumsasthecash
receiptsjournalentries.Answer(c)isincorrectbe
causethebankdepositslipswillbeidenticaltoany
detailsincludedinthemonthlybankstatements.
Answer(d)isincorrectbecausewhilethewriteoffof
areceivablemayhelptheindividualinvolvedinthe
lappingtoavoidrepayment,nolagistobeexpected
betweenauthorizationofthewriteoffandthedateitis
actuallyrecorded.
78. (c)Therequirementistodeterminethe
individualororganizationtowhichalistof
remittancesshouldbeforwardedtoin
additiontothecashier.Answer(c)is
correctbecausetheaccountsreceivable
bookkeeperwillusethelistingtoupdatethe
subsidiaryaccountsreceivablerecords.
Answer(a)isincorrectbecauseinternal
auditorswillnotnormallyinvestigateeach
dayslistingofremittancesforunusual
transactions.Answer(b)isincorrect
becausethetreasurerwillnotingeneral
comparedailylistingstothemonthlybank
statement.Answer(d)isincorrectbecause
thelistwillnotbesenttothebank.
79. (d)Therequirementistoidentifytheprocedurethat
mostlikelywouldnotbeacontroldesignedtoreduce
theriskoferrorsinthebillingprocess.Answer(d)is
correctbecausethereconciliationofthecontroltotals
forsalesinvoiceswiththeaccountsreceivable
subsidiaryledgerwillfollowbilling;thusbillingerrors
willhavealreadyoccurred.Answer(a)isincorrect
becauseidentificationofdifferencesinshipping
documentsandsalesinvoiceswillallowfora
correctionofanyerrorsandproperbilling.Answer(b)
isincorrectbecausecomputerprogrammedcontrols
willassuretheaccuracyofthesalesinvoice.Answer
(c)isincorrectbecausethematchingofshipping
documentswiththeapprovedsalesorderswillallow
thepreparationofacorrectinvoice.
80. (b)Therequirementistoidentifytheaudit
procedureanauditormostlikelywould
performtotestcontrolsrelatingto
managementsassertionconcerningthe
completenessofsalestransactions.
Answer(b)iscorrectbe
causeinspectionofshippingdocumentsthathave
notbeenrecordedinthesalesjournalwillpossibly
revealitemsthathavebeensold(asevidencedbya
shippingdocument)butforsomereasonhavenot
beenrecordedassales.Answers(a),(c),and(d)are
allincorrectbecauseverificationofextensionand
footings,comparinginvoicedprices,andinquiring
aboutcreditgrantingpoliciesallrelatemoredi
rectlytothevaluationassertionthantothe
completenessassertion.
99
81. (a)Therequirementistoidentifythecontrol
thatmostlikelywouldassurethatallbilled
salesarecorrectlypostedtotheaccounts
receivableledger.Answer(a)iscorrect
becausethedailysalessummarywillinclude
allbilledsalesforaparticularday.
Comparingthissummarytothepostingsto
theaccountsreceivableledgerwillprovide
evidenceonwhetherbilledsalesare
correctlyposted.Answer(b)isincorrect
becausecomparingsalesinvoicestoshipping
documentsprovidesevidenceonwhether
invoicedsaleshavebeenshipped.Answer(c)
isincorrectbecausereconcilingtheaccounts
receivableledgertothecontrolaccountwill
notprovideassurancethatallbilledsales
werepostedinthatboththereceivableledger
andthecontrolaccountmayhaveomitted
thesales.Answer(d)isincorrectbecause
comparingshipmentswithsalesinvoices
providesevidenceonwhetherallshipments
havebeeninvoiced,notonwhetherallbilled
salesarecorrectlyposted.
82. (a)Therequirementistodeterminethe
financialstatementassertionbeingmost
directlytestedwhenanauditortestsan
entityspolicyofobtainingcreditapproval
beforeshippinggoodstocustomers.Answer
(a)iscorrectbecausetestingcreditapproval
helpsassurethatgoodsareshippedto
customerswhoarelikelytobeabletopay;
accordinglythevaluationassertionfor
receivablesisbeingdirectlytested.Answer
(b)isincorrectbecausecompletenessdeals
withwhetheralltransactionsandaccounts
arerecorded.Answer(c)isincorrect
becauseexistencedealswithwhetherassets
existatagivendateandwhetherrecorded
transactionshaveoccurredduringagiven
period.Answer(d)isincorrectbecause
rightsandobligationsdealwithwhether
assetsaretherightsoftheentityand
liabilitiesaretheobligationsoftheentityat
agivendate.
83. (d)Therequirementistoidentifythecontrol
thatmostlikelywouldhelpensurethatall
creditsalestransactionsarerecorded.
Answer(d)iscorrectbecausethematching
ofshippingdocumentswithentriesinthe
salesjournalwillprovideassurancethatall
shippeditems(sales)havebeencompletely
recorded.Answer(a)isincorrectbecause
comparisonofapprovedsalesordersto
authorizedcreditlimitsandbalanceswill
helpensurethatcustomercreditlimitsare
notexceeded,ratherthanthecompletere
cordingofcreditsales.Answer(b)is
incorrectbecausereconciliationofthe
accountsreceivablesubsidiaryledgertothe
accountsreceivablecontrolaccountwill
provideonlyalimitedamountofcontrol
overthecompleterecordingofsales.The
controlisincompletesince,forexample,a
salethathasnotbeenrecordedineitherthe
subsidiaryorcontrolaccountswillnotbe
detected.Answer(c)isincorrectbecause
monthlystatementsgenerallywillnotbe
senttocustomerstowhomnosaleshave
beenrecorded.
84. (c)Therequirementistoidentifythecontrolthatwillbe
mosteffectiveinoffsettingthetendencyofsales
personneltomaximizesalesvolumeattheexpenseof
highbaddebtwriteoffs.Answer(c)iscorrectbecause
segregationoftheauthorizationofcreditfromthesales
functionwillallowanindependentreviewofthe
creditworthinessofcustomers.Answer(a)isincorrect
becausewhiledenyingaccesstocashbyemployees
responsibleforsalesandbaddebtwriteoffsmaydeter
embezzlements,theproblemofhighbaddebtwriteoffs
islikelytoremain.Answer(b)isincorrectbecausewhile
sosegregatingthematchingofshippingdocumentsand
salesinvoicesmayhelpassurethatitemsareshipped
properlyandsubsequentlyrecorded,itwill
100
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
notsignificantlyaffectbaddebts.Answer(d)is
incorrectbecausewhileindependentreconciliation
ofcontrolandsubsidiaryaccountsreceivable
recordsmaydeferembezzlements,baddebtwrite
offswillnotbeaffected.
reconciliationofcheckingaccountswiththemonthly
bankstatementwillnotreflectcashthathasbeen
improperlydivertedbytheaccountsreceivableclerk.
Answer(d)isincorrectbecausetheaccounts
receivableclerkshouldbeabletomaintainthedetail
andledgeramountinbalanceandtherebyavoid
detection.
85. (d)Therequirementistodeterminethe
88. (b)Therequirementistodeterminewhoshould
departmentthatshouldapprovebaddebt
preparearemittanceadvicewhenthecustomerfailsto
writeoffs.Thedepartmentresponsiblefor
includeonewitharemittance.Remittancesshouldbe
baddebtwriteoffsshouldbeindependentof
openedbyanindividualsuchasareceptionistwhois
thesales,credit,andtherecordkeepingfor
independentofthesalesfunction.Thatindividualwill
thatfunction,andshouldhaveknowledge
prepareanyneededremittanceadvices.Thecredit
relatingtotheaccounts.Answer(d)is
manager[answer(a)],andthesalesmanager[answer
correctbecause,inadditiontobeing
(c)],areincorrectbecausethey
independentofthevariousfunctions,the
treasurersdepartmentislikelytohave
knowledgetohelpmakeproperdecisionsof
thisnature.Answers(a)and(b),accounts
receivableandthecreditdepartment,are
incorrectbecauseneitherdepartmentisin
dependentofthisfunction.Answer(c)is
incorrectbecausewhileaccountspayableis
independentofthefunction,itspersonnelare
lesslikelythanthoseofthetreasurersde
partmenttohavethenecessaryinformation
relatingtotheaccountsthatshouldbe
writtenoff.
86. (b)Therequirementistoidentifyareason
thatemployersbondemployeeswho
handlecashreceipts.Answer(b)iscorrect
becauseemployeeknowledgethatbonding
companiesoftenprosecutethoseaccusedof
dishonestactsmaydeteremployees
dishonestacts.Answer(a)isincorrect
becausebondingprotectstheemployer
fromdishonestacts,nottheemployeefrom
unintentionalerrors.Answer(c)isincorrect
becausethebondingcompanydoesnot
servetheroleofindependentmonitoringof
cash.Answer(d)isincorrectbecausewhile
rotationofpositionsandforcingemployees
totakeperiodicvacationsareeffective
controlsforpreventingfraud,theyarenot
accomplishedthroughbonding.
87. (c)Therequirementistoidentifythecontrolwhich
wouldoffsetaweaknessthatallowedtheaccounts
receivableclerktoapprovecreditmemosandtohave
accesstocash.Notethatsuchaweaknessmayleadto
afraudinwhichtheaccountsreceivableclerkreceives
andkeepscashpaymentswhileissuingafraudulent
creditmemoasthebasisforacredittothecustomers
account.Answer(c)iscorrectbecausetheowners
reviewofcreditmemoscouldhelpestablishthat
fraudulentmemoshadnotbeenissuedforreceivables
whichhadinactualitybeencollectedbytheclerk;for
example,whenreviewingcreditmemostheowner
wouldexpecttoseeareceivingreportforsalesreturns
forwhichcreditmemoshavebeengenerated.Answer
(a)isincorrectbecausethebookkeepermaybeableto
maintaintherecordsinsuchamannerastoavoid
billingerrorsrelatedtothefraud,andthereforea
reviewofbillingsandpostingsmaynotrevealsuch
fraud.Answer(b)isincorrectbecausemonthend
performanauthorizationfunctionrelatedtosales.
Answer(d)isincorrectbecausetheaccounts
receivableclerkperformsarecordkeepingfunction
forsales.
D.2.Purchases,Payables,andCashDisbursements
89. (b)Therequirementistoidentifytheaudit
procedurerelatingtopaidvouchersthat
willprovideassurancethateachvoucheris
submittedandpaidonlyonce.Answer(b)
iscorrectbecausewhenthechecksigner
stampsvoucherspaiditisunlikelytobe
paidasecondtimesincethatindividualwill
noticethestamponthevoucherthesecond
timeitissubmittedforpayment.
mentsmostdirectlyaddresses.Answer(b)is
correctbecausetheexistenceoroccurrence
assertionaddresseswhetherrecordedentries
arevalidandthedirectionofthistestisfrom
therecordedentryinthevoucherregisterto
thesupportingdocuments.Answer(a)is
incorrectbecausecompletenessaddresses
whetheralltransactionsandaccountsare
includedandwouldinvolveteststracing
fromsupportforpurchasestotherecorded
entry.Answers(c)and(d)areincorrect
becausevouchingtheentriesprovidesonly
limitedevidenceonvaluationandrights.
92. (d)Therequirementistodeterminethe
controlthatisnotusuallyperformedinthe
voucherspayabledepartment.Answer(d)
iscorrectbecausethevoucherspayable
departmentwillnotingeneralhaveaccess
tounusedprenumberedpurchaseorders
andreceivingreports.An
swer(a)isincorrectbecausethevoucherspayable
departmentwillmatchthevendorsinvoicewith
therelatedreceivingreporttodeterminethatthe
itemforwhichthecompanyhasbeenbilledhas
beenreceived.Answer(b)isincorrectbecausethe
voucherspayabledepartmentwillapprovevouchers
forpaymentwhenalldocumentationisproperand
present.Answer(c)isincorrectbecausethe
voucherspayabledepartmentwillcodethevoucher
withaccountstobedebited.
90. (d)Therequirementistodeterminethe
appropriateresponsibilityforthepersonwho
signschecks.Answer(d)iscorrectbecause
theindividualwhosignschecksshouldbe
responsibleformailingthemsoastoavoida
varietyoffraudinwhichthechecksare
improperlyconvertedintocashbycompany
employees.Answer(a)isincorrectbecause
theindividualwhoreconcilesthebank
accountsshouldhavenoother
responsibilitieswithrespecttocash.Answer
(b)isincorrectbecauseaccountspayable
doesnotneedthechecksand,iftheyreceive
them,thosechecksmaybeconvertedinto
cashwhichisthenstolen.Answer(c)is
93. (b)Therequirementistoidentifythefunctionthatis
incorrectbecausethepersonwhosignsthe
consistentwithmatchingvendorsinvoiceswith
checksshoulddeterminethatproper
receivingreports.Answer(b)iscorrectbecausewhile
supportingdocumentsexistandshould
matchinginvoicesandreceivingreports,the
cancelthatdocumentationafterthepayment
employeemighteffectivelyrecomputethecalculations
ismade.
onthevendorsinvoicestodeterminethatthe
amountsareproper.Answers(a)and(c)areincorrect.
91. (b)Therequirementistodeterminethe
Theindividualwhomatchestheinvoicesandreceiving
financialstatementassertionthatatestof
reportswilloftenalsoapprovethemforpayment.
controlsofvouchingasampleofentriesin
Therefore,thisindividualshouldnotalsopost
thevoucherregistertothesupportingdocu
accountspay
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
ablerecordsorreconciletheaccountspayableledger.
Answer(d)isincorrectbecausetheindividualwho
controlsthesigningofthechecksshouldcancelthe
invoicesafterpayment.
94. (b)Therequirementistoidentifythe
populationfromwhichitemsshouldbe
selectedtodeterminewhetherchecksare
beingissuedforunauthorizedexpenditures.
Answer(b)iscorrectbecauseasampleof
canceledchecksshouldbeselectedand
comparedwiththeapprovedvouchers,a
prenumberedpurchaseorderand
prenumberedreceivingreports.Acanceled
checkthatdoesnothavesuchsupportmay
havebeenunauthorized.Answers(a),(c),
and(d)areallincorrectbecauseselecting
itemsfrompurchaseorders,receiving
reports,orapprovedvoucherswillnot
revealcircumstancesinwhichacheckwas
issuedwith
outthatsupportingdocument.Forexample,when
selectingasamplefrompurchaseorders,onewould
notdiscoverasituationinwhichacheckhadbeen
issuedwithoutapurchaseorder.
95. (d)Therequirementistodeterminewhichquestion
wouldmostlikelybeincludedinaninternalcontrol
questionnaireconcerningthecompletenessassertion
forpurchases.Answer(d)iscorrectbecause
prenumberingandaccountingforpurchaseorders,
receivingreports,andvoucherswillallowacompany
todeterminethatpurchasesarecompletelyrecorded.
Forexample,inexaminingareceivingreportthe
clientmightdiscoverthatthepurchasewasnot
recorded.Answer(a)isincorrectbecauserequiringa
purchaseorderbeforeashipmentisacceptedwill
addresswhetherornottheshipmenthasbeenordered.
Answer(b)isincorrectbecausematchingpurchase
requisitionswithvendorinvoicesdoesnotdirectly
addresswhetherthepurchaseisrecorded.Answer(c)
isincorrectbecausetheunpaidvoucherfilerepresents
itemsthathavealreadybeenrecorded,andthuswill
notdirectlyaddressthecompletenessoftherecording
ofpurchases.
96. (d)Therequirementistoidentifythepropercontrol
pertainingtotheaccountspayabledepartment.Answer
(d)iscorrectbecausetheaccountspayabledepartment
shouldestablishtheagreementofthevendorsinvoice
withthepurchaseorderandreceivingreporttoprovide
assurancethattheitemwasbothorderedandreceived.
Answer(a)isincorrectbecausetheindividualsigning
thecheck(e.g.,thetreasurer),nottheaccountspayable
department,shouldstamp,perforate,orotherwise
cancelsupportingdocumentationafteracheckis
signed.Answer(b)isincorrectbecausepurchase
requisitionswillnotnormallyincludedetailedprice
information.Answer(c)isincorrectbecausethe
quantityorderedonthereceivingdepartmentcopyof
thepurchaseorderwillalreadybeobliteratedwhenthe
purchaseorderiscompletedbythepurchasing
department.
97. (b)Therequirementistodeterminewhichcopyofthe
purchaseordershouldomitindicationofthequantity
101
ofmerchandiseordered.Answer(b)iscorrectbecause
ifthereceivingdepartmentpersonnelareunawareof
thequantitiesordered,theywillprovidean
independentcountofquantitiesreceived.Answer(a)is
incorrectbecausethedepartmentthatinitiatedthe
requisitionneedsthemerchandise,andtherefore,
shouldknowwhathasbeenordered.Answer(c)is
incorrectbecausethepurchasingagentisinvolved
withpurchasingtheitemsandthereforemustbeaware
ofthequantityinvolved.Answer(d)isincorrect
becausetheac
inspectgoodsuponreceipt.Answer(c)isincorrect
becauseusergroupsorstoreswillauthorize
requisitionsofgoods.Keepinmindtheprincipleof
segregationoffunctions.Recordkeeping,
authorization,andcustodialfunctionsshouldallbe
segregated.
D.3.InventoriesandProduction
100. (c)Therequirementistoidentifythemost
likelyprocedureanauditorwouldperform
inobtaininganunderstandingofa
manufacturingentitysinternalcontrolfor
inventorybalances.Answer(c)iscorrect
becauseareviewoftheentitysdescriptions
ofinventorypoliciesandprocedureswill
helptheauditortoobtainthenecessary
understandingaboutthedesignofrelevant
policies,procedures,andrecords,and
whethertheyhavebeenimplementedbythe
entity.Answers(a)and(b)areincorrect
becauseanalysesofliquidityandturnover
ratiosareanalyticalproceduresdesignedto
identifycostvariancesthatwillhelpthe
auditorprimarilytodeterminethenature,
timingandextentofauditingproceduresthat
willbeusedtoobtainevidenceforspecific
accountbalancesorclassesoftransactions.
Answer(d)isincorrectbecausetestcounts
ofinventoryaregenerallyobtainedasa
substantiveprocedure.
101. (d)Therequirementistoidentifythecontrolthatmost
likelywouldbeusedtomaintainaccurateinventory
records.Answer(d)iscorrectbecauseperiodic
inventorycountswillassurethatperpetualinventory
recordsareaccurateand,becauseemployeeswill
knowthatinventorydifferencesareinvestigated,they
willbelesslikelytostealanyinventory.Answer(a)is
incorrectbecausecomparingtheperpetualinventory
recordswithcurrentcostsofitemswillreveal
situationsinwhichcostshavechanged,butisunlikely
tohelpinthemaintenanceofaccurateinventory
records.Answer(b)isincorrectbecausewhileajust
intimeinventoryorderingsystemmayhelpassure
thatinventoryrecordsareaccurate(aswellaskeptat
lowlevels),suchasystem
102
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
generallyalsorequiresperiodicinventorycountsto
maintainaccurateinventoryrecords.Answer(c)is
incorrectbecausematchingrequisitions,receiving
reports,andpurchaseordersonlyhelpsassurethatitems
receivedarepaidfor;thematchingprocessdoesnot
assureaccurateinventoryrecords.
102. (d)Therequirementistodeterminealikelyeffecton
theauditofinventoryiftheassessedlevelofcontrol
riskishigh.Answer(d)iscorrectbecauseahigh
assessedlevelofcontrolriskmayresultinchanging
thetimingofsubstantiveteststoyearendratherthan
ataninterimdate.Iftheassessedlevelofcontrolrisk
islow,theauditorcouldperforminterimsubstantive
testsandrelyuponinternalcontroltoprovidevalid
yearendrecords.However,becausetheassessedlevel
ofcontrolriskishigh,thecontrolscannotberelied
upon.Also,thenatureofsubstantivetestsmaychange
fromlesseffectivetomoreeffectiveprocedures(e.g.,
useofindependentpartiesoutsidetheentityrather
thaninternal)andanincreaseintheextentof
procedures(e.g.,largersamplesizes).Answer(a)is
incorrectbecause,asindicated,anauditorwill
generallyseekayearendcountofinventory.Answer
(b)isincorrectbecausegrossprofittestswillnotin
generalhavetherequiredprecisionwhencontrolrisk
ishigh.Answer(c)isincorrectbecausetestsof
controlsarelikelytosubstantiateanauditorsview
thatcontrolriskishigh,anditisthereforeunlikelythat
theirperformancewillbecosteffective.
103. (c)Therequirementistoidentifythecontrol
whichismostlikelytoaddressthe
completenessassertionforinventory.
Answer(c)iscorrectbecauseby
prenumberingreceivingreportsandby
reconcilingthemwithinventoryrecords,one
isabletotestcompletenessbydetermining
whetherallreceiptshavebeenrecorded.
Answer(a)isincorrectbecausereconciling
thesubsidiaryrecordswiththeworkin
processwillonlyidentifydiscrepancies
betweentherecords,itwillnotidentify
whetheralltransactionsthatshouldbeinthe
inventoryrecordsarerepresentedinthe
records.Answer(b)isincorrectbecause
whilethesegregationofreceivingfrom
custodyoffinishedgoodsisimportant,it
lessdirectlyaddressescompletenessthan
doesanswer(a).Answer(d)isincorrect
becauseseparatingthedutiesbetweenthe
payrolldepartmentandinventoryac
countingpersonneldoesnotdirectlyaddress
completenessofinventory.
104. (c)Therequirementistodeterminetheproperinter
nalcontrolforhandlingcustomerreturnsofdefective
merchandise.Answer(c)iscorrectbecausethe
receivingdepartmentcancountthegoods,andlist
themonasalesreturnnoticetodeterminethatallsuch
returnsareproperlyrecorded.Thisservesasacontrol
becausethenormalproceduresofthereceiving
functionincludeestablishingtheoriginal
accountabilityandrecordkeepingforitemsreceived.
Answers(a),(b),and(d)allrepresentfunctionsnot
typicallyinvolvedinthereceivingfunctionandthus
involveahigherriskrelatingtoestablishing
accountability.
105. (c)Therequirementistoidentifytheeffect
onrevenues,receivables,andinventoryof
inadequatecontrolsovertheinvoicing
functionthatallowsgoodstobeshipped
withoutbeinginvoiced.Itemsshipped
withoutinvoicingwillresultinasituationin
whichtheaccountingdepartmentisunaware
ofthesale.Therefore,debitstoaccounts
receivableandcreditstosaleswillnotbe
recorded,resultinginanunderstatementof
bothrevenuesandreceivables.Similarly,
becauseaccountingisunawareofthesale,noentry
toreduceinventorywillbemade,resultinginan
overstatementofinventory.
106. (c)Therequirementistoidentifythe
questionthatanauditorwouldexpecttofind
ontheproductioncyclesectionofan
internalcontrolquestionnaire.Answer(c)is
correctbecauseapprovedrequisitionswill
helpmaintaincontroloverrawmaterials
releasedtobeusedintheproductioncycle.
Answers(a),(b),and(d)areallincorrectbe
causeapprovalofvendorsinvoicesfor
payment,mailingofchecksaftersigning,
andcomparingindividualdisbursementsto
totalsallpertainmoredirectlytothe
disbursementcycle.
107. (b)Therequirementistodeterminean
objectiveofinternalcontrolforaproduction
cycleinadditiontoprovidingassurancethat
transactionsareproperlyexecutedand
recorded.Answer(b)iscorrectbecause,in
additiontoprovidingassuranceastoproper
executionandrecording,anobjectiveforthe
productioncycle(aswellasothercycles)is
thesafeguardingofassets,hereworkin
processandfinishedgoods.Answers(a),(c),
and(d)areincorrectbecausetheyrepresent
detailedcontrolsestablishedtohelpachieve
theoverallobjectives.Theyareallmuch
morespecificthantheoverallobjectives.
D.4.PersonnelandPayroll
108. (b)Therequirementistoidentifyapurposeofvouching
dataforasampleofemployeesinapayrollregisterto
approvedclockcarddata.Answer(b)iscorrectbecause
theclockcarddataprovidestheauditorwithevidenceon
whetheremployeesworkedthenumberofhoursfor
whichthepayrollregisterindicatestheywerepaid.An
swer(a)isincorrectbecauseclockcarddataoftendoes
notincludeauthorizedpayrates.Answer(c)isincorrect
becausetheproceduredoesnotdirectlyaddressthe
segregationofdutiessincenoinformationisprovided
concerningthedistributionofthepayroll.Answer(d)is
incorrectbecauseunclaimedpayrollchecksarenotbeing
analyzed.
109. (a)Therequirementistoidentifythecontrol
thatmostlikelycouldhelppreventemployee
payrollfraud.Answer(a)iscorrectbecause
promptnotificationofthepayrollsupervisor
concerningterminationswillleadtotimelyre
movalofterminatedemployeesfromthe
payroll.Accordingly,nopayrollcheckswillbe
preparedforsuchterminatedemployees.
Answer(b)isincorrectbecauseunclaimedpay
rollchecksshouldnotbereturnedtothe
supervisorswhomightinappropriatelycash
them.Answer(c)isincorrectbecausesincethe
payrolldepartmentisinvolvedinrecord
keeping,itshouldnotapprovesalaryrates.
Answer(d)isincorrectbecausecalculationof
totalhoursbythepayrollsupervisorisunlikely
topreventemployeepayrollfraud.
110. (a)Therequirementistodeterminethebest
procedurefordeterminingtheeffectiveness
ofanentityscontrolsrelatingtothe
existenceoroccurrenceassertionforpayroll
transactions.Answer(a)iscorrectbecause
propersegregationofdutiesbetween
personnelandpayrolldisbursement
eliminatesmanyfraudsinwhichphantom
employeesarebeingpaid.Answer(b)is
incorrectbecauseaccountingforthe
prenumberedpayrollchecksaddresses
completenessmoredirectlythanitdoes
existenceoroccurrence.Answer(c)is
incorrectbecauserecomputingpayroll
deductionsforemployeefringebenefits,
withoutadditionalanalysis,
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
providesonlyaverylimitedtestofexistenceor
occurrence.Answer(d)isincorrectbecauseverifying
thepreparationofthemonthlypayrollaccountbank
reconciliationisunlikelytoprovideevidenceonthe
existenceoroccurrenceassertion,althoughsome
possibilitydoesexistifsignaturesonchecksare
analyzedindetail.
111. (c)Therequirementistoidentifythe
situationinwhichitismostlikelythatan
auditorwouldassesscontrolriskforpayroll
atahighlevel.Answer(c)iscorrectbe
causethepayrolldepartment,whichis
essentiallyarecordkeepingfunction,
shouldnotalsoauthorizepayrollrate
changes.Understronginternalcontrol
recordkeeping,authorization,andcustody
overassetsshouldbesegregated.Answer
(a)isincorrectbecauseexamining
authorizationformsfornewemployeesis
consistentwiththepayrolldepartments
recordkeepingfunction.Answer(b)is
incorrectbecausecomparingpayroll
registerswithoriginalbatchtransmittaldata
isacontrolrelatingtorecordkeeping.An
swer(d)isincorrectbecausewhilethe
actualhiringofemployeesisnormally
doneinthepersonneldepartment,allowing
thepayrolldepartmentsupervisortohire
subordinates,withproperapproval,isnotas
inconsistentwithpayrollsrecordkeeping
functionasisauthorizingratechangesfor
allemployees.
112. (c)Therequirementistoidentifythecontrolmost
likelytopreventdirectlaborhoursfrombeingcharged
tomanufacturingoverhead.Answer(c)iscorrect
becausetimeticketsmaybecodedastowhetherdirect
laboronvariousprojectswasinvolved.Accordingly,
usingtimeticketswillhelpidentifydirectlaborcosts.
Answer(a)isincorrectbecausewhileperiodiccounts
ofworkinprocessmayprovideacontroloverphysical
unitsofproduction,thecountswillnotingeneral
provideassurancethatdirectlaborhoursareproperly
chargedtotheproductratherthantomanufacturing
overhead.Answer(b)isincorrectbecausecomparing
dailyjournalentrieswithproductionorderswillnotin
generalidentifycoststhathavebeenomittedfrom
directlaborduetothelevelofaggregationofthe
entries.Answer(d)isincorrectbecausethe
reconciliationofworkinprocessinventorywith
budgetswillprovideonlyverylimiteddetectionability
relatingtothechargingofdirectlaborto
manufacturingoverhead.
113. (a)Therequirementistodeterminetheindividual(s)
whoshoulddistributepaychecksandhavecustodyof
unclaimedpaychecks.Answer(a)iscorrectbecause
thesecustodyfunctionsshouldnotbeperformedby
thepayrolldepartmentwhichisarecordkeeping
function.Underproperinternalcontrolrecordkeeping,
custody,andauthorizationoftransactionsshouldbe
segregated.
114. (c)Ifpaymentofwagesweretobeincash,
eachemployeereceivingpaymentshouldbe
103
requiredtosignareceiptfortheamountof
payreceived.Thus,therewouldbecontrol
overthetotalamountdisbursedaswellas
amountsdisbursedtoeachindividual
employee.Answer(a)isincorrectbecauseif
asignedreceiptisnotreceivedfromeach
employeepaid,therewouldbenoproofof
payment.Eventhoughthepayenvelopes
includebothcashandacomputationofnet
wages,theemployeesshouldhavethe
opportunitytocountthecashreceivedbefore
signingapayrollreceipt.Answer(b)is
incorrectbecauseunclaimedpayenvelopes
shouldnotberetainedbythepaymaster,but
ratherdepositedinabankaccountbythe
cashier.An
swer(d)isincorrectbecausethewagepaymentwillbe
madeincashandnotbycheck.Accordingly,areceipt
mustbeobtainedforeachcashpayment.
115. (a)Therequirementistoidentifythepurpose
ofsegregatingthedutiesofhiringpersonnel
andofdistributingpayrollchecks.Answer(a)
iscorrectbecausethehiringofpersonnelisan
authorizationfunctionwhilethedistributionof
checksisacustodyfunction.Thus,inorderto
properlysegregateauthorizationfromcustody,
thesedutiesshouldnotbeperformedbythe
sameindividual.Thecombinationofthesetwo
functionsinthesamepositionwouldcreatethe
possibilityoftheadditionofafictitious
employeetothepayrollandsubsequent
misappropriationofpaychecks.Answer(b)is
incorrectbecausethefunctionsinvolvedare
notprimarilyoperationalorrecordkeeping.
Answer(c)isincorrectbecausethetreasury
function,andnotthecontrollershipfunction,
willnormallyberesponsiblefordistributing
payrollchecks.Answer(d)isincorrectbecause
segregationofdutiesdoesnotdirectlyaddress
administrativecontrolsvs.internalaccounting
controls.
116. (c)Therequirementistodeterminethebest
method to minimize the opportunities for
fraudforunclaimedcash
inacashpayrollsystem.Foracashpayrollthebest
controlistogettheunclaimedcashoutofthefirms
physicalcontrolandintothebank.Answer(a)is
incorrectbecausemaintainingtheaccountabilityfor
cashwhichisinasafedepositboxisdifficult.
Answers(b)and(d)areincorrectbecausethecash
neednotbekeptbythefirm.
117. (c)Therequirementistoidentifyareasonwhyan
auditormayobservethedistributionofpaychecks.An
swer(c)iscorrectbecauseanemployeespresenceto
collectthepaycheckprovidesevidencethatthe
employeeactuallyexistsandiscurrentlyemployedby
theclient.Answer(a)isincorrectbecausethe
distributionsofpayrollcheckswouldnotreveal
whetherpayrateauthorizationisproperlyseparated
fromtheoperatingfunction.Answer(b)isincorrect
becausethepaycheckdistributiondoesnotprovide
informationonwhetherdeductionsfromgrosspay
havebeencalculatedproperly.Answer(d)isincorrect
becauseobservationofthepaycheckdistribution
processdoesnotofitselfprovideassurancethatthe
paychecksagreewiththerelatedpayrollregisterand
timecards.
118. (a)Therequirementistodeterminethe
departmentmostlikelytoapprovechangein
payratesanddeductionsfromemployee
salaries.Answer(a)iscorrectbecausethe
personneldepartment,whichhastheprimary
objectiveofplanning,controllingand
coordinatingemployees,willdeterminethat
proposedsalaryincreases(often
recommendedbysupervisorsofemployees)
areconsistentwiththecompanyssalary
guidelinesandwillapprovechangesin
deductions.Answers(b)and(c)are
incorrectbecausethetreasurerand
controllerwillingeneralinitiatethepayrate
changeprocessforonlythoseemployees
withintheirdepartmentsandwillnot
generallyapprovechangesforemployees
outsidetheirdepartments.Answer(d)is
incorrectbecausethepayrollfunctionsisa
recordkeepingfunctionwhichwillmodify
employeepayratesbasedonapproved
changesfrompersonnel.Payrollshouldnot
haveauthorityregardingpayratesand
deductions.
104
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
D.5.Financing
119. (d)Therequirementistodeterminethemostlikely
questionthatwouldbeincludedonaninternalcontrol
questionnairefornotespayable.Answer(d)iscorrect
becausecompaniesfrequentlyrequirethatdirect
borrowingsonnotespayablebeauthorizedbythe
boardofdirectors;accordingly,auditorswill
determinewhetherproperpolicyhasbeenfollowed.
Answer(a)isincorrectbecauseinternalcontrol
questionnairesdonotingeneralincludequestionson
whetherassetsthatcollateralizenotespayableare
criticallyneeded.Answer(b)isincorrectbecausethe
internalcontrolquestionnairefordisbursementsis
morelikelytoaddresstherequiredauthorized
signaturesonchecksthanwilltheinternalcontrol
questionnairefornotespayable.Answer(c)is
incorrectbecausewhileitisoftengoodbusiness
practicetouseproceedsfromlongtermnotesto
purchasenoncurrentassets,thisisnotrequiredandis
notincludedonaninternalcontrolquestionnaire.
120. (d)Therequirementistoidentifythe
primaryresponsibilityofabankactingas
registrarforcapitalstock.Answer(d)is
correctbecausetheprimaryresponsibilityof
thestockregistraristopreventany
overissuanceofstock,andtherebyverify
thatthestockisissuedproperly.Answer(a)
isincorrectbecauseregistrarwillnotin
generaldeterminethatthedividendamounts
areproper.Answer(b)isincorrectbecause
thetransferagentwillmaintainrecordsof
totalsharesoutstandingaswellasdetailed
stockholderrecords,andcarryouttransfers
ofstockownership.Answer(c)isincorrect
becauseregistrarsdonotperformtherole
describedrelatingtomergers,acquisitions,
andthesaleoftreasurystock.
121. (a)Canceledstockcertificatesshouldbedefacedand
attachedtocorrespondingstubsasisdonewithvoided
checks.Theobjectiveofthecontrolistoprevent
reissuance.Answer(b)isincorrectbecausefailureto
defacepermitsreissuance.Answer(c)isincorrect
becausedestructionofthecertificateswouldpreclude
theircontrol(i.e.,theirexistenceafterdefacing
providesassurancethattheycannotbereissued).Ifthe
certificatesweredestroyed,oneormoremightbe
reissuedwithoutanyproofthatsuchoccurred.Answer
(d)isincorrectbecausetheSecretaryofStatehasno
interestinreceivingdefacedandcanceledstock
certificates.
D.6.Investing
122. (a)Therequirementistoidentifythereply
whichisnotacontrolthatisdesignedto
protectinvestmentsecurities.Answer(a)is
notacontrolsincethecustodyofsecurities
shouldbeassignedtoindividualswhodo
nothaveaccountingresponsibilityfor
securities;aswithotherassets,
authorization,recordkeeping,andcustody
shouldbeseparated.Answer(b)isincorrect
becausesecuritiesshouldbeproperly
controlledphysicallyinordertoprevent
unauthorizedusage.Answer(c)isincorrect
becauseaccesstosecuritiesshould
ordinarilybevestedintwoindividualssoas
toassuretheirsafekeeping.Answer(d)is
incorrectbecausesecuritiesshouldbe
registeredinthenameoftheowner.
123. (b)Therequirementistoidentifythebest
controlforsafeguardingmarketable
securitieswhenanindependenttrustagentis
notemployed.Answer(b)iscorrectbecause
requiringjointcontroloversecurities
maintainedinasafedepositboxassures
that,absentcollusion,assetsaresafe
guarded.Answer(a)isincorrectbecausea
reviewofin
vestmentdecisionsbytheinvestmentcommitteewill
haveaverylimitedeffectonsafeguarding
marketablesecurities.Answer(c)isincorrectbecause
thesimpletracingofmarketablesecuritiesfromthe
subsidiaryledgerstothegeneralledgerdoesnot
directlysafeguardmarketablesecuritiessince,for
example,unrecordedtransactionsmayoccur.Answer
(d)isincorrectbecause,evenifthechairmanofthe
boarddidverifymarketablesecuritiesonthebalance
sheetdate,thecontrolwillonlybeeffectiveatthat
pointintime.
124. (d)Therequirementistoidentifythebest
auditprocedurewhenaweaknessininternal
controloverreportingofretirementsexists.
Answer(d)iscorrectbecauseselecting
certainitemsofequipmentfromthe
accountingrecordsandattemptingtolocate
themwillrevealsituationsinwhichthe
accountingrecordsstillhavethemrecorded
subsequenttotheirretirement.Answer(a)is
incorrectbecauseinspectingitemsthatstill
existisnotlikelytoleadtodiscoveryofun
recordedretirements.Answer(b)isincorrect
becausedepreciationmaycontinuetobe
takenonequipmentthathasbeenretired,but
notrecorded.Answer(c)isincorrectbe
causeitisdoubtfulthatsuchretirements
havebeenreclassifiedasotherassets.
125. (d)Therequirementistoidentifythe
questionthatisleastlikelytobeincludedon
aninternalcontrolquestionnaireconcerning
theinitiationandexecutionofequipment
transactions.Answer(d)iscorrectbecause
procedurestomonitorandproperlyrestrict
accesstoequipmentdonotrelatedirectlyto
theinitiationandexecutionofequipment
transactions.Answer(a)isincorrectbecause
requestsformajorrepairsrelatetoinitiation
ofatransactionwhichshouldbecontrolled.
Answer(b)isincorrectbecausepre
numberedpurchaseordersmaybeusedto
controlallpurchases,includingpurchasesof
equipment.Answer(c)isincorrectbecause
thesignificantamountsofmoneyinvolved
withpurchasesofequipmentsuggestthe
needforthesolicitationofcompetitivebids.
126. (d)Therequirementistoidentifythecontrolthat
wouldbemosteffectiveinassuringthattheproper
custodyofassetsintheinvestingcycleismaintained.
Answer(d)iscorrectbecausecomparingrecorded
balancesintheinvestmentsubsidiaryledgerwith
physicalcountswillhelpassurethatrecordedassets
arethoseoverwhichthecompanyhascustody.Thisis
anexampleofthecontrolactivityofcomparisonof
assetswithrecordedaccountability.Answer(a)is
incorrectbecauseinternalcontrolisimprovedwhen
twoindividuals,notone,mustbepresentforentryto
thesafedepositbox.Answer(b)isincorrectbecause
whilethesegregationofdutieswithinthe
recordkeepingmayincertaincircumstancesbe
desirable,itdoesnotdirectlyaddresscustodyover
assets.Answer(c)isincorrectbecauseonlyextremely
majorinvestmentsgenerallyneedbeauthorizedbythe
boardofdirectors.
127. (d)Therequirementistodeterminewho
shouldhaveresponsibilityforcustodyof
shorttermbearerbondinvestmentsandthe
submissionofcouponsforperiodic
collectionsofinterest.Thetreasurer
authorizessuchtransactions.Answer(a)is
incorrectbecausethechiefaccountant,who
isinchargeoftherecordkeepingfunction,
shouldnotalsomaintaincustodyofthe
bonds.Answer(b)isincorrectbecausethe
internalauditorshouldnotbedirectlyin
volvedassuchinvolvementwouldmakean
independentreviewofthesystem
impossible.Answer(c)isincorrect
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
because the cashier function is more directly
involvedwithdetailssuchasendorsing,depositing,
andmaintainingrecordsofcashreceipts.
128. (b)Therequirementistoidentifythecontrolthat
wouldbemostlikelytoassistanentityinsatisfying
thecompletenessassertionrelatedtolongterm
investments.Answer(b)iscorrectbecause
completenessdealswithwhetheralltransactionsare
recorded,andthecomparisonofsecuritiesinthebank
safedepositboxwithrecordedinvestmentsmay
revealsecuritieswhichareinthesafedepositboxbut
arenotrecorded.Answer(a)isincorrectbecause
verificationofsecurityregistrationhelpsestablishthe
rightsassertionnotthecompletenessassertion.Answer
(c)isincorrectbecausevouchingtheacquisitionof
securitiesbycomparingbrokersadviceswith
canceledcheckshelpstoestablishtheexistence
assertionnotthecompletenessassertion.Answer(d)
isincorrectbecauseacomparisonofthecurrent
marketpricesofrecordedinvestmentswithbrokers
advicesaddressesthevaluationassertionnotthe
completenessassertion.
129. (a)Therequirementistoidentifythebestcontrolfor
safeguardingmarketablesecuritiesagainstloss.An
swer(a)iscorrectbecauseuseofanindependenttrust
companyallowstheeffectiveseparationofcustody
andrecordkeepingforthesecurities.Answer(b)is
incorrectbecauseaverificationofmarketable
securitiesatthebalancesheetdatemayhaveonlya
limitedeffectonsafeguardingthesecurities
throughouttheyear.Answer(c)isincorrectbecause
tracingallpurchasesandsalesofmarketablesecurities
willnotaffectsecuritiesthathavedisappearedfor
whichnoentrieshavebeenmade.Also,itisunlikely
thatanentitywillrelyupontheindependentauditorin
thismanner.Answer(d)isincorrectbecause
maintenanceofcontrolovercustodybyamemberof
theboardofdirectorsmayprovidelesscomplete
controlthantheuseofanindependenttrustcompany.
130. (c)Therequirementistodeterminethe
appropriatecombinationofaudittestswhen
therearenumerouspropertyandequipment
transactionsduringtheyearandtheauditor
planstoassesscontrolriskatalowlevel.
Answer(c)iscorrectbecause,tojustifyan
assessmentofcontrolriskatalowlevel,tests
ofcontrolswillberequired.Thiswillallow
auditorstoperformonlylimitedtestsof
currentyearpropertyandequipment
transactions.Answer(a)isincorrectbecause
testsofcontrolswillbeperformedtoallow
theauditortoperformlimited,notextensive,
testsofpropertyandequipmentbalancesat
theendoftheyear.Answers(b)and(d)are
incorrectbecauseanalyticalprocedureson
eitheryearendbalancesortransactionswill
notjustifyalowassessedlevelofcontrol
risk.
D.7.OverallInternalControlQuestionnaires
(Check
lists)
105
131.(d)Therequirementistodeterminethetype
offraudwhichismostdifficulttodetect.Answer(d),
afraudcommittedbythecontroller,ismostdifficult
todetectbecausethecontrollerisincontrolofthe
recordkeepingfunctionandthusmaybeableto
commitafraudandthenmanipulatetheaccounting
recordssoastomakeitsdiscoveryunlikely.Answer
(a)isincorrectbecausewhileacashiermaybeable
toembezzlefunds,s/hewillnothaveaccesstothe
accountingrecordsandthusdiscoveryofthe
embezzlementwillbelikely.Answer(b)isincorrect
becauseakey
punchoperatorwillnotingeneralhaveaccessto
assets.Answer(c)isincorrectbecauseaninternal
auditorwillnotgenerallybeabletomanipulatethe
accountingrecordsandgenerallyhaslimitedaccess
toassets.
E.1.a.CommunicationofInternalControlRelated
Matters
135. (d)Therequirementistoidentifythe
statementthatshouldbeincludedinan
auditorsletteronsignificantdeficiencies.
Answer(d)iscorrectbecauseAU325
indicatesthatsuchalettertotheaudit
committeeshould(1)indicatethatthe
auditspurposewastoreportonthe
financialstatementsandnottoexpressan
opiniononinternalcontrol,
(2)includethedefinitionofasignificantdeficiency,
and
(3)restrictdistributionofthereport.
132. (c)Answer(c)iscorrectbecauseweaknessesthatwere
communicatedinthepastandnotcorrectedmustbe
recommunicatedtomanagementandthosecharged
withgovernance.Answers(a),(b),and(d)areall
136. (c)Therequirementistoidentifythecorrectstatement
accuratestatementsaboutauditrequirements.
133. (c)Therequirementistoidentifythematteranauditor
wouldmostlikelyconsidertobeamaterialweakness
tobecommunicatedtothosechargedwithgovern
ance.Answer(c)iscorrectbecauseineffective
oversightoffinancialreportingbythosechargedwith
governanceisanindicatorofamaterialweakness(AU
325).Answers(a),(b),and(d)areallincorrect
becauseafailuretorenegotiateunfavorablelongterm
purchasecommitments,recurringoperatinglosses,and
planstoreduceownershipequitydonotfallwithinthe
definitionofamaterialweakness.
134. (c)Therequirementistoidentifythecorrectstate
mentconcerningsignificantdeficienciesidentifiedin
anaudit.Answer(c)iscorrectbecauseanauditormay
communicatesignificantdeficiencieseitherduringan
auditoraftertheauditscompletion.Answer(a)is
incorrectbecauseanauditorneednotsearchfor
significantdeficiencies.Answer(b)isincorrect
becauseallsignificantdeficienciesarenotalso
materialweaknesses.Answer(d)isincorrectbecause
anauditormaynotissueawrittenreportthatnosig
nificantdeficiencieswerenotedduringanaudit.
concerninganauditorsrequiredcommunicationof
significantdeficiencies.Answer(c)iscorrectbecause
distributionofanauditorsreportonsignificant
deficienciesshouldberestrictedtomanagementandthe
auditcommittee.Answer(a)isincorrectbecauselackof
correctionofasignificantdeficiencydoesnot
necessarilyresultinascopelimitation.Answer(b)is
incorrectbecausetestsofcontrolsneednotbeperformed
relatingtosignificantdeficiencies.Answer(d)is
incorrectbecausealthoughtimelycommunicationof
significantdeficienciesmaybeimportant,depending
uponthenatureofthesignificantdeficiencyidentified,
theauditormaychoosetocommunicateiteitherafterthe
auditisconcludedorduringthecourseoftheaudit.
137. (d)Therequirementistoidentifythecorrect
statementaboutsignificantdeficienciesnoted
inanaudit.Answer(d)iscorrectbecausethe
auditorshouldseparatelyidentifyand
communicatematerialweaknessesand
significantdeficiencies(AU325).Answer(a)
isincorrectbecausesignificantdeficienciesare
lessseverethanmaterialweaknesses.Answer
(b)isincorrectbecausetheauditoris
106
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
notobligatedtosearchforsignificantdeficiencies.
Answer(c)isincorrectbecausesuchdeficiencies
shouldberecommunicated.
138. (b)Therequirementistodeterminethe
representationthatshouldnotbeincluded
inareportoninternalcontrolrelated
mattersnotedinanaudit.Answer(b)is
correctbecausetheauditorsshouldnotissue
areportoninternalcontrolstatingthatno
significantdeficiencieswereidentified
duringtheaudit.Answer(a)isincorrect
becausesignificantdeficienciesshouldbe
disclosed.Answer(c)isincorrectbecausean
auditormayrecommendcorrectivefollow
upaction.Answer(d)isincorrectbecausean
auditormaydisclosethefactthatthe
considerationofinternalcontrolwouldnot
necessarilydiscloseallsignificant
deficienciesthatexist.
139. (b)Therequirementistoidentifythe
correctstatementregardingmaterial
weaknessesandsignificantdeficiencies.
Answer(b)iscorrectbecausea
compensatingcontrolisacontrolthat
lessenstheseverityofadeficiency(AU
325).Answer(a)isincorrectbecause
materialweaknessesshouldbereported
separatelyfromsignificantdeficiencies.
Answer(c)isincorrectbecausewhilethe
auditormaychoosetocommunicate
materialweaknessandsignificant
deficienciesimmediately,the
communicationmayoccuratothertimes.
Answer(d)isincorrectbecausesignificant
deficienciesarelessseverethanmaterial
weaknesses.
140. (b)Therequirementistodeterminean
auditorsresponsibilityafters/hehas
discoveredandorallycommunicated
informationonaweaknessininternalcontrol
totheclientsseniormanagementandthose
chargedwithcorporategovernance.Answer
(b)iscorrectbecausetheauditor,asoutlined
throughoutAU318,considersand
documentshis/herunderstandingofinternal
controltoassistinplanninganddetermining
thepropernature,timing,andextentof
substantivetests.Answer(a)isincorrect
becausenoscopelimitationisindicated
althoughaninternalcontrolconditiondoes
exist.Similarly,answers(c)and(d)are
incorrectbecauseauditactivitiesneednot
besuspendedandtheauditorneednot
withdrawfromtheengagement.
E.1.b TheAuditorsCommunicationwith
ThoseChargedwithGovernance
141. (b)Therequirementistodeterminethematterthatan
auditorwouldcommunicatetothosechargedwith
governance.Answer(b)iscorrectbecauseAU380
requiresthatwhentheauditorisawareofsuch
consultationwithanotherCPA,s/heshoulddiscuss
withtheauditcommitteehis/herviewsabout
significantmattersthatwerethesubjectofsuch
consultation;accordingly,suchadiscussionwith
managementistobeexpected.Whiletheinformation
suggestedinanswers(a),(c),and(d)mayallbe
communicatedtotheauditcommittee,theyarenot
includedasrequireddisclosuresunderAU380.See
AU380forthevariousmattersthatmustbe
communicatedtothosechargedwithgovernance.
142. (b)Therequirementistoidentifythe
correctstatementconcerninganauditors
requiredcommunicationwiththosecharged
withgovernance.Answer(b)iscorrectbe
causethecommunicationshouldinclude
suchinformationondisagreements.SeeAU
380forthisandotherrequired
communicationswiththosechargedwith
governance.An
swer(a)isincorrectbecausethecommunicationmay
occurbeforeorafterissuanceoftheauditorsreport.
Answer(c)isincorrectbecausenotallmattersneedbe
communicatedtomanagement.Answer(d)is
incorrectbecausesignificantadjustmentsneedtobe
communicatedtothosechargedwithgovernance.
143. (b)Therequirementistoidentifythe
discussionthatitisleastlikelythatan
auditorwillinitiatewiththosechargedwith
governance.Answer(b)iscorrectbecause
auditorsdonotgenerallyinitiateadiscussion
onmateriality,althoughtheydooccasionally
respondtosuchquestions.SeeAU380for
auditorcommunicationswiththosecharged
withgovernance.
144. (b)Therequirementistoidentifythecorrect
statementaboutanauditorsrequired
communicationwiththosechargedwith
governance.Answer(b)iscorrectbecause
thecommunicationmustincludesignificant
misstatementsdiscovered,evenifcorrected
bymanagement.Answer(a)isincorrect
becausewhilesuchcommunicationsmaybe
communicatedtomanagement,thereisno
suchrequirement.Answer(c)isincorrect
becausedisagreementswithmanagement,
aswellastheotherrequireddisclosures,
maybecommunicatedeitherorallyorin
writing.Answer(d)isincorrectbecausean
auditormustrecommunicatesuch
weaknessesininternalcontrol.Also,seeAU
380forthematterscommunicatedtothose
chargedwithgovernance.
145. (a)Therequirementistodeterminewhetherdis
agreementswithmanagementandinitialselectionof
significantaccountingpoliciesneedtobe
communicatedtothosechargedwithcorporate
governance.Answer(a)iscorrectbecause
disagreementsshouldbecommunicateddirectlyto
thosechargedwithcorporategovernance.Answer(b)
isincorrectbecausedirectcommunicationbythe
auditorisnotrequiredforselectionofaccounting
principles.Managementmayengageinthis
communicationwiththosechargedwithcorporate
governance.Answer(c)isincorrectbecausethe
auditoronlyneedstomakesurethatmanagementhas
communicatedwiththecommitteeconcerninginitial
selectionofsignificantaccountingpoliciesin
emergingareasthatlackauthoritativeguidance.
Answer(d)isincorrectbecausedisagreementsshould
becommunicateddirectlytothosechargedwith
corporategovernance.
146. (a)Therequirementistodeterminethe
informationthatanauditorshould
communicatetothosechargedwithcorporate
governance.Answer(a)iscorrectbecauseboth
significantauditadjustmentsand
managementsconsultationwithother
accountantsaboutsignificantaccounting
mattersshouldbecommunicatedtoanaudit
committee.See
AU380fortheseandothermattersthatshouldbe
socommunicated.
E.2.ReportingonInternalControl
147. (d)Therequirementistoidentifythe
statementthatshouldbeincludedina
CPAsreportonaclientsinternalcontrol
overfinancialreporting.Answer(d)is
correctbecauseAT501requiresthatthe
reportincludeacommentontheinherent
limitationsofanyinternalcontrol.
148. (a)Therequirementistoidentifythe
statementthatbestdescribesaCPAs
engagementtoreportonanentitysinternal
controloverfinancialreporting.Answer(a)
iscorrectbecausetheobjectiveofan
attestationengagementistoformanopinion
ontheeffectivenessofinternalcontrol.
Answer(b)isincorrectbecausenosuch
negativeassurance
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
isprovidedbasedonanauditoftheentitys
internalcontrol.Answer(c)isincorrectbecausesuch
engagementsdonotprojectexpectedbenefitsofthe
entitysinternalcontrol.Answer(d)isincorrect
becausesuchengagementsareattestation
engagements,notconsultingengagements.
149. (c)Therequirementistodeterminethecorrectstatement
regardinganengagementtoexamineinternalcontrol.
Answer(c)iscorrectbecausetheproceduresrelatingto
internalcontrolwillbemoreextensivewhenreportingon
internalcontrolascomparedtoproceduresperformedfor
afinancialstatementaudit.Thisdifferenceoccurs
becauseduringfinancialstatementauditstheauditormay
decidenottoperformtestsofcontrolsandmaysimply
assesscontrolriskatthemaximumlevel.Conversely,in
anengagementtoreportoninternalcontrolanauditor
mustperformadditionaltestsofcontrols.Answer(a)is
incorrectbecausesuchduplicationofproceduresmay
notbenecessary.Answer(b)isincorrectbecauseareport
oninternalcontrolwillnotingeneralincreasethe
reliabilityofthefinancialstatements.Answer(d)is
incorrectbecause,asindicated,thescopeofprocedures
relatingtointernalcontrolismoreextensive,notmore
limited,thantheassessmentofcontrolriskmadeduring
afinancialstatementaudit.
150. (d)Therequirementistoidentifythe
relationshipbetweenanexaminationof
internalcontrolandobtainingan
understandingofinternalcontroland
assessingcontrolriskaspartofanaudit.
Answer(d)iscorrectbecause,whilethe
scopeandpurposedifferbetweenthetwo
typesofengagements,theprocedures
followedaresimilar.SeeAT501(or
PCAOBStandard5)forinformationon
reportingonanauditofinternalcontrol.
151. (b)Therequirementistodescribethe
contentsofareportonthestudyofinternal
controlthatisbasedoncriteriaestablished
bygovernmentalagencies.Answer(b)is
correctbecausethereportshouldindicate
matterscoveredbytheconsiderationand
whethertheauditorsconsiderationincluded
testsofcontrolswiththeprocedurescovered
byhis/herconsideration.Additionally,the
reportshoulddescribetheobjectivesand
limitationsofinternalcontrolandthe
accountantsevaluationthereof;statethe
accountantsconclusion,basedonthe
agencyscriteria;anddescribethepurposeof
thereportandstatethatitshouldnotbeused
foranyotherpurpose.Answer(a)is
incorrectbecausetheagencysnameshould
beincluded.Answer(c)isincorrectbecause
aconclusionmaybemaderelativetothe
agencyscriteria.Answer(d)isincorrect
becausetheaccountantshouldnotassume
responsibilityforthecomprehensivenessof
thecriteria.
152. (b)AT501statesthatwhenadeviationfrom
thecontrolcriteriabeingreportedupon
107
exists(hereamaterialweaknessininternal
control)theCPAshouldreportdirectlyupon
thesubjectmatterandnotuponthe
assertion.
E.3.EffectsofanInternalAuditFunction
153.(a)Therequirementistoidentifythemost
likelyinformationaCPAwouldobtaininassessingthe
competenceofaninternalauditor.Answer(a)is
correctbecauseinassessingcompetence,aninternal
auditorwillconsiderthequalityofworkingpaper
documentationaswellasavarietyofotherfactors
outlinedinAU322.Answer(b)isincorrectbecause
anorganizationscommitmenttointegrityandethical
values,whileimportant,doesnotbearasdirectlyupon
internalauditorcompetence.Answers(c)and(d)are
incorrectbecausetheinfluenceofmanagementand
theorganizationalleveltowhichtheinternalauditor
reportsarefactorsusedtoassessinternalauditor
objectivity.AU322providesoverallguidanceonthe
useofinternalauditors.
154. (d)Therequirementistodeterminewhether
theindependentauditormayshare
responsibilitywithanentitysinternal
auditorforassessinginherentriskand
controlrisk.AU322requiresthat
judgmentsaboutinherentandcontrolrisk
alwaysbethoseoftheindependentauditor.
Italsorequiresthatjudgmentsaboutthe
materialityofmisstatements,the
sufficiencyoftestsperformed,thevaluation
ofsignificantaccountingestimates,and
othermattersaffectingtheauditorsreport
shouldalwaysbethoseoftheindependent
auditor.SeeAU322forinformationonthe
externalauditorsconsiderationofthe
internalauditfunction.
155. (d)Theworkofinternalauditorsmayaffect
thenature,timingandextentoftheaudit,
including(1)procedurestheauditor
performswhenobtaininganunderstanding
oftheentitysinternalcontrol,(2)
procedurestheauditorperformswhen
assessingrisk,and(3)substantiveproce
durestheauditorperforms.
156. (c)Therequirementistoidentifythe
circumstanceinwhichaninternalauditors
workwouldmostlikelyaffectthenature,
timing,andextentofaCPAsauditing
procedures.Whenconsideringtheeffectof
theinternalauditorswork,theCPA
considers(1)thematerialityoffinancial
statementamounts,(2)theriskofmaterial
misstatementoftheassertions,and(3)the
degreeofsubjectivityinvolvedinthe
evaluationoftheauditevidence.Answer(c)
iscorrectbecausetheexistenceoffixed
assetadditionsinvolveslittlesubjectivity.
Answers(a)and(b)areincorrectbecause
theexistenceofcontingenciesandthe
valuationofintangibleassetsaresubjective
andtheriskofmisstatementmaybehigh.
Answer(d)isincorrectbecausethe
valuationofrelatedpartytransactionsmay
beverysubjectiveduetothelackofan
armslengthtransaction.
157. (d)AU322statesthatinternalauditorsmayassistthe
CPAinobtaininganunderstandingofinternalcontrol,
inperformingtestsofcontrols,andinperforming
substantivetests.
158. (b)Therequirementistoidentifythetype
ofinformationusedbyaCPAtoassessthe
competenceofinternalauditors.Answer(b)
iscorrectbecause,alongwithvariousother
factors,AU322indicatesthattheCPA
shouldobtainevidenceontheeducational
backgroundandprofessionalcertificationof
theinternalauditorswhenconsideringcom
petence.Answers(a)and(c)areincorrect
becauseanalysisoforganizationallevelto
whichtheinternalauditorsreportand
policiesonrelativesareconsideredwhen
assessinginternalauditorobjectivity.
Answer(d)isincorrectbecauseaccessto
sensitiverecordswillnotprovideaCPA
withinformationoncompetence.
159. (d)Therequirementistoidentifytheleast
likelysourceofinformationtotheCPAon
anentitysinternalauditorscompetenceand
objectivity.Answer(d)iscorrectbecause
analyticalproceduresdonotordinarily
provideinformationontheinternalauditor.
SeeAU329forinformationonanalytical
procedures.
108
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
160. (a)Therequirementistoidentifythe
characteristicsofaninternalauditorwhich
mustbeconsideredbyanindependent
auditorwhodecidesthattheinternalauditors
workmighthaveabearingonhis/her
procedures.Answer(a)iscorrectbecause
independentauditorsmustconsiderinternal
auditorcompetence,objectivity,andwork
performance.Answer(b)isincorrectbecause
anindependentauditorislessconcerned
aboutinternalauditorefficiency,although
internalauditorexperiencewillbeconsidered
intheassessmentofcompetence.Answers
(c)and(d),whilepartiallycorrect,areless
completethananswer(a).
161. (d)Therequirementistodeterminehowa
CPAshouldassesstheobjectivityofan
internalauditor.Answer(d)iscorrect
becausewhenassessingtheobjectivityofan
internalauditortheCPAshouldconsider
organizationalstatusandpoliciesfor
maintainingobjectivity.Answers(a),(b),and
(c)areallincorrectbecauseevaluatingthe
qualitycontrolprogram,andexaminingand
testinganinternalauditorsworkallrelate
moredirectlytoassessinginternalauditor
competenceratherthantoobjectivity.See
AU322fortheseandotherfactors
consideredwhenassessinginternalauditor
competence.
E.4.ReportsontheProcessingofTransactionsby
ServiceOrganizations
162. (a)Therequirementistoidentifythe
informationprovidedinaserviceauditors
reportwhichincludesanopinionona
descriptionofcontrolsimplemented.An
swer(a)iscorrectsincesuchareport
includesadescriptionofthescopeand
natureoftheCPAsprocedures.Answers
(b),(c),and(d)areallincorrectbecausethey
suggestinformationnotincludedinsucha
report.SeeAU324forinformationonthe
auditofserviceorganizations.
163. (a)TherequirementistoidentifyaCPAs
reportingresponsibilitywhenreportingon
internalcontrolimplementedforaservice
organizationthatprocessespayroll
transactions.Answer(a)iscorrectbecause
sincetheCPAisonlyexpressinganopinion
onwhethercontrolshavebeenimplemented,
adisclaimershouldbeprovidedonoperating
effectiveness.Answer(b)isincorrectbecause
nospecificstatementismadewithrespectto
earlierobjectives.Answer
(c)isincorrectbecausecontrolsrelevanttofinancial
statementassertionsarenotsoidentified.Answer(d)
isincorrectbecausetheassessedlevelofcontrolriskis
notdisclosed.SeeAU324forinformationon
processingoftransactionsbyserviceorganizations.
164. (a)Therequirementistodetermine
whetheranauditorwhoauditsthe
processingoftransactionsbyaservice
organizationmayissueareportoneither,
orboth,ofwhethercontrolshavebeen
implementedandcontroloperating
effectiveness.Answer(a)iscorrect
becauseAU324indicatesthatsuch
serviceauditorsmayissueeitherofthe
twotypesofreports.
165. (a)Therequirementistoidentifythe
properinformationtobeincludedina
serviceauditorsreportonwhethera
clientscontrolshavebeenimplemented.
Answer(a)iscorrectbecausesuchareport
shouldincludeadescriptionofthescope
andnatureoftheclientsprocedures.
166. (d) The requirement is to determine the
propriety of a computer user auditor
(Lake)makingreferencetoaser
viceauditors(Cope)report.Answer(d)iscorrect
becausetheuserauditorshouldnotmakereferenceto
thereportoftheserviceauditor.SeeAU324for
reportsontheprocessingoftransactionsbyservice
organizations.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
SOLUTIONSTOSIMULATIONS
TaskBasedSimulation1
CashReceipts
andBilling
Authoritative
Literature
Help
1.
5.
8.
Condition
Southwestisinvolvedonlyinmedicalservicesandhasnot
diversifieditsoperations.
2.
Insurancecoverageforpatientsisverifiedandcommunicatedto
the clerks by the office manager before medical services are
rendered.
3.
Thephysicianwhorendersthemedicalservicesdocumentsthe
servicesonaprenumberedslipthatisusedforrecordingrevenue
andasareceiptforthepatient.
4.
CashcollectioniscentralizedinthatClerk#2receivesthecash
(checks)frompatientsandrecordsthecashreceipt.
Southwestextendscreditratherthanrequiringcashorinsuranceinall
cases.
6.
Theofficemanagerextendscreditonacasebycasebasisrather
thanusingaformalcreditsearchandestablishedcreditlimits.
7.
Theofficemanagerapprovestheextensionofcredittopatients
and also approves the writeoffs of uncollectible patient
receivables.
Clerk#2receivescashandchecksandpreparesthedailybankdeposit.
9.
Clerk#2maintainstheaccountsreceivablerecordsandcan
addordeleteinformationonthePC.
10. Prenumberedserviceslipsareaccountedforonamonthlybasisbythe
outsideaccountantwhoisindependentoftherevenuegeneratingand
revenuerecordingfunctions.
11. The bank reconciliation is prepared monthly by the outside
accountant who is independent of the revenue generating and
revenuerecordingfunctions.
12. Computerpasswordsareonlyknowntotheindividualemployees
and the managing partner who has no duties in the revenue
recordingfunctions.
13. ComputersoftwarecannotbemodifiedbySouthwestsemployees.
14. Noneoftheemployeeswhoperformduties intherevenue
generatingandrevenuerecordingareabletowritechecks.
109
Strength
Weakness
Neither
TaskBasedSimulation2
Purchasesand
Disbursements
1.
2.
5.
Authoritative
Literature
Help
(C)PreparepurchaseorderAtrapezoidrepresentsamanualoperation.Here,apurchaseorderenters
theflowchartafterthisstep;accordingly,apurchaseorderisbeingprepared.
(R) TovendorAcirclerepresentsaconnector,asymbolindicatingthatadocumentisenteringorleavingthat
portionoftheflowchart.Hereacopyofthepurchaseorderissenttothevendortoorderthegoods.Thismustbethe
case,becauseotherwisethevendorwouldnotbeinformedoftheorder.
3.
(F)PreparereceivingreportAtrapezoidrepresentsamanualoperation.Here,areceivingreportenters
theflowchartafterthisstep;accordingly,areceivingreportisbeingprepared.Also,noteabovethisstep
thatgoodsarereceived,thepointatwhichonewouldexpectpreparationofareceivingreport.
4.
(L)FrompurchasingAcirclerepresentsaconnector,asymbolindicatingthatadocumentisenteringor
leavingthatportionoftheflowchart.Thedocumenthereisfrompurchasingbecausebelowtheconnector
isrequisitionNo.1,whichpurchasinghassentwiththepurchaseorderNo.5tovoucherspayable,as
evidencedbytheconnectorinthebottomfarrightunderpurchasing.
(M)FromreceivingAcirclerepresentsaconnector,asymbolindicatingthatadocumentisenteringorleavingthat
portionoftheflowchart.Thedocumenthereisfromreceivingbecauseunderthereceivingportionoftheflowchart,
approximately
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
110
3/4ofthewaydown,weseeaconnectorindicatingthatreceivingreportNo.1isbeingsenttovoucherspayable.Also,toward
thebottomunderthevoucherspayableportionoftheflowchart,weseethatreceivingreportNo.1isindeedinthesystem.
6.
(O)PurchaseorderNo.5Weknowfromitem4thatthisdocumentwassentfrompurchasing,andweknowthat
purchasinghassenttovoucherspayablerequisitionNo.1andpurchaseorderNo.5.SincerequisitionNo.1is
labeledontheflowchart,thismustbepurchaseorderNo.5.
7.
(P)ReceivingreportNo.1Weknowfromitem5thatthisdocumentwassentfromreceiving,andsinceweknow
thatreceivinghassentreceivingreportNo.1tovoucherspayablethismustbethatdocument.
8.
(B)PrepareandapprovevoucherAtrapezoidrepresentsamanualoperation.Here,anapprovedvoucherenters
theflowchartafterthisstep;accordingly,avoucherisbeingpreparedandapprovedinthisstep.
9.
(T)Unpaidvoucherfile,filedbyduedateThetrianglesymbolrepresentsafile.Enteringthisfilearetheapproved
butunpaidvoucherswiththesupportoftheirinvoices,receivingreports,purchaseordersandpurchaserequisitions.
Becausethesevouchersaresenttothetreasurerinorderofduedate(thebottom,rightsymbolundervouchers
payable)thisfileistheunpaidvoucherfile,filedbyduedate.
10. (S) TreasurerBecausethe unpaid vouchers(the voucher package)was sent from vouchers payable to the
treasurer,thisisthetreasurer.
11. (I)SignchecksandcancelvoucherpackagedocumentsAtrapezoidrepresentsamanualoperation.Here,the
operationpriorto11involvesareviewofdocumentsandpreparationofacheckandaremittanceadvice.Afterthis
operationthedocumentschangedareacanceledvoucherpackagefileandasignedcheck;accordingly,checks
arebeingsignedandthevoucherpackageisbeingcanceled.
12. (K)CanceledvoucherpackageAfterstep11,thecheckcopy,remittanceadviceNo.1,thesignedcheck,andremittance
adviceNo.2exitonthefarright.Accordingly,item12isthevoucherpackage,nowcanceledasevidencedbythedescription
belowthetriangularfilesymbol.
TaskBasedSimulation3
Research
Authoritative
Literature
Help
(A)(B)(C)(D)(E)(F)(G)(H)
1. WhichtitleoftheProfessionalStandardsaddressesthisissue?
2. Entertheexactsectionandparagraphnumbersthatdescribethelimitations.
319
6466
TaskBasedSimulation4
Sales/Shipping
Process
1.
Help
(M)PerformcustomercreditcheckThecustomercreditfileisbeingaccessed,makingitlikelythatacreditcheckisoccurring.
2.
6.
Authoritative
Literature
(Z)OpenorderfileTheprocessingtotherightof#2beginswithopenorders,makingthisanopenorderfile.
3.
(L)MatchcustomerpurchaseorderwithsalesorderTwocopiesofthesalesorderarebeingcombinedwiththe
customerpurchaseorderthroughamanualoperation(thetrapezoid).
4.
(B)VerifyagreementofsalesorderandshippingdocumentThismanualoperation(trapezoid)includestwocopies
oftheshippingdocumentbeingcombinedwiththesalesorder.
5.
(H) Release goods for shipmentThe department is the warehouse and shipping department, and out of this
operationisshippinginformation;accordinglygoodsarebeingreleasedforshipment.
(S) MasterpricefileTheoperationbelow#6includesenteringpricedata;sincethefirsttwofilesbeingaccessedarethe
accountsreceivablemasterfileandtheshippingfile,thisthirdfilemustincludeprices.
7.
8.
(O)PreparesalesinvoiceSinceadocumentisbeingpreparedthroughthiscomputerizedbillingprogram,itisthe
salesinvoice.
(U)SalesinvoiceAsalesinvoiceisnormallysenttothecustomer.
9.
(I)ToaccountsreceivabledepartmentThiscopyofthesalesinvoiceinformsaccountsreceivablethatthesalehas
beenbothprocessedandshipped.
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
111
10. (Q)GeneralledgermasterfileBecausetheprocessingstepbelowincludesupdatingofmasterfiles,thisisthe
generalledgermasterfile.
11. (N)PreparesalesjournalSalestransactionsarebeingprocessed;accordinglyasalesjournalisprepared.
12. (T)SalesjournalFromabove,asalesjournalwasprepared;theaccountingdepartmentwillreceivethesalesjournal.
13. (Y)AgedtrialbalanceIntheprocessingstepabove,anagedtrialbalanceofaccountsreceivableisprepared;the
creditdepartmentwillreceivesuchareport.
TaskBasedSimulation5
Research
Authoritative
Literature
Help
501
TaskBasedSimulation6
PurchasingReceiving,
andAccountsPayable
Authoritative
Literature
Help
1.
Disagree.Someoneindependentofrequisitioningshouldselectthesupplier.
2.
Agree.
3.
Disagree.Often,factorsinadditiontocostareconsidered(e.g.,quality,dependability).
4.
Agree.
5.
Agree.
6.
Agree.
7.
Disagree. A comparison of quantities is not possible because quantity is blacked out on the purchase order
providedtoreceiving.
8.
Noreceivingreportisordinarilynecessaryforpurchasesofservices.
9.
Agree.
10. Agree.
11. Agree.
12. Disagree.Thereconciliationshouldbeperformedbyanindependentparty.
13. Disagree.Documentationshouldbemarkedpaidbytheindividualmakingthepayment.
14. Agree.
15. Agree.
T
R
e
A
u
L
i
MODULE3UNDERSTANDINGINTERNALCONTROLANDASSESSINGCONTROLRISK
112
TaskBasedSimulation8
MattersCommunication
InternalControlRelated
Authoritative
Literature
Help
AU325.25includesthemattersrequiredtobeincludedinthewrittencommunicationregardingsignificant
deficienciesandmaterialweaknessesindentifiedduringanauditas
Statethatthepurposeoftheauditwastoexpressanopiniononthefinancialstatements,butnottoexpress
anopinionontheeffectivenessoftheentitysinternalcontroloverfinancialreporting.
Statethattheauditorisnotexpressinganopinionontheeffectivenessofinternalcontrol.
Includethedefinitionofthetermssignificantdeficiencyand,whererelevant,materialweakness.
Identifythemattersthatareconsideredtobesignificantdeficienciesand,ifapplicable,thosethatare
consideredtobematerialweaknesses.
Statethatthecommunicationisintendedsolelyfortheinformationanduseofmanagement,those
chargedwithgovernance,andotherswithintheorganizationandisnotintendedtobeandshouldnot
beusedbyanyoneotherthanthosespecifiedparties.Ifanentityisrequiredtofurnishsuchauditor
communicationstoagovernmentalauthority,specificreferencetosuchgovernmentalauthoritiesmay
bemade.
Internalcontrols
Statethatthepurposeoftheauditwastoexpress
anopiniononthefinancialstatements,andto
expressanopinionontheeffectivenessofthe
entitysinternalcontroloverfinancialreporting.
Relatedmatters
Excluded
Comment
Thelatterpartofthesentenceis
incorrectsincenoopinionon
internalcontroleffectivenessis
issued.
Identify,ifapplicable,itemsthatareconsideredto
bematerialweaknesses.
Included
Required
Statethattheauthorisnotexpressinganopinion
ontheeffectivenessofinternalcontrol.
Included
Required
Includethedefinitionofthetermsignificant
deficiency.
Included
Required
Includethedefinitionofthetermmaterial
weakness,whererelevant.
Included
Required
Statethattheauthorisexpressinganunqualified
opinionontheeffectivenessofinternalcontrol.
Excluded
Theauditorexpressesnoopinion
oninternalcontrol.
Statethatthecommunicationisintendedsolelyfor
managementandexternalparties.
Excluded
Thecommunicationisnot
intendedforexternalparties.
Included
Required
Identifythemattersthatareconsideredtobe
significantdeficiencies.
TaskBasedSimulation9
Research
Authoritative
Literature
Help
(A)(B)(C)(D)(E)(F)(G)(H)
1.WhichtitleoftheProfessionalStandardsaddressesthisissue?
2.Entertheexactsectionandparagraphwithhelpfulinformation.
MODULE4RESPONDINGTORISKASSESSMENT
RESPONDINGTORISKASSESSMENT:
5
113
14
EVIDENCEACCUMULATIONANDEVALUATION
MULTIPLECHOICEQUESTIONS(1169)
1.
2.
a.
b.
c.
d.
3.
Whichofthefollowingisnotanassertion
relatingtoclassesoftransactions?
Accuracy.
Consistency.
Cutoff.
Occurrence.
Which of the following is a general
principlerelatingtothereliabilityofaudit
evidence?
a. Auditevidenceobtainedfrom
indirectsourcesratherthandirectly
ismorereliablethanevidence
obtaineddirectlybytheauditor.
b.
c.
Auditevidenceobtainedfrom
knowledgeableindependentsources
outsidetheclientcompanyismore
reliablethanauditevidence
obtainedfromnonindependent
sources.
Auditevidenceprovidedby
originaldocumentsismorereliable
thanauditevidencegenerated
throughasystemofeffective
controls.
d.
4.
a.
b.
c.
d.
5.
obtained
indirectly from outside
sources is the most reliable
auditevidence.
b. Tobereliable,auditevidence
should be convincing rather
thanpersuasive.
c. Reliabilityofauditevidencerefers
d.
6.
d.
c.
7.
8.
a.
b.
c.
d.
9.
a.
b.
c.
d.
Inevaluatingthereasonablenessofan
entitysaccountingestimates,anauditor
normallywouldbeconcernedabout
assumptionsthatare
Susceptibletobias.
Consistentwithpriorperiods.
Insensitivetovariations.
Similartoindustryguidelines.
Which of the following is not a basic
procedureusedinanaudit?
Riskassessmentprocedures.
Substantiveprocedures.
Testsofcontrols.
Testsofdirectevidence.
10. Whichofthefollowingprocedureswould
anauditorordinarilyperformfirstin
evaluatingmanagementsaccounting
estimatesforreasonableness?
a. Develop
independent
expectations of managements
estimates.
b. Considertheappropriatenessofthe
d.
keyfactorsorassumptionsusedin
preparingtheestimates.
Test the calculations used by
management in developing the
estimates.
Obtain an understanding of how
management developed its
estimates.
11. Inevaluatingthereasonablenessofan
accountingestimate,anauditormostlikely
wouldconcentrateonkeyfactorsand
assumptionsthatare
a. Consistentwithpriorperiods.
b. Similartoindustryguidelines.
c. Objectiveandnotsusceptibletobias.
d. Deviationsfromhistoricalpatterns.
12. Inevaluatinganentitysaccounting
estimates,oneofanauditorsobjectivesisto
determinewhethertheestimatesare
a. Notsubjecttobias.
b. Consistentwithindustryguidelines.
c. Basedonobjectiveassumptions.
d. Reasonableinthecircumstances.
13. In testing the existence assertion for an
asset,anauditorordinarilyworksfromthe
a. Financial statements to the
potentiallyunrecordeditems.
b. Potentiallyunrecordeditemstothefinancial
statements.
c. Accounting records to the supporting
evidence.
d. Supporting evidence to the accounting
records.
MODULE4RESPONDINGTORISKASSESSMENT
114
b.
14. Aclientusesasuspenseaccount
forunresolvedquestionswhose
finalaccountinghasnotbeen
determined.Ifabalanceremains
inthesuspenseaccountatyear
end,theauditorwouldbemost
concernedabout
a. Suspense debits that
managementbelieves
will benefit future
operations.
b. Suspensedebitsthatthe
auditor verifies will
haverealizablevalueto
theclient.
c. Suspense credits that
management believes should be
classifiedasCurrentliability.
d. Suspense credits that
the auditor determines
tobecustomerdeposits.
15. Whichofthefollowingwould
notbeconsideredananalytical
procedure?
a. Estimatingpayroll
expensebymultiplying
thenumberof
employeesbythe
averagehourlywage
rateandthetotalhours
worked.
b. Projectinganerrorrate
by comparing the
results of a statistical
samplewiththeactual
population
characteristics.
c.
d.
Developing
the
expected current year
salesbasedonthesales
trend of the prior five
years.
16. Whattypeofanalytical
procedurewouldanauditormost
likelyuseindeveloping
relationshipsamongbalance
sheetaccountswhenreviewing
thefinancialstatementsofa
nonpublicentity?
a. Trendanalysis.
b. Regressionanalysis.
c. Ratioanalysis.
d. Riskanalysis.
17. Anauditormayachieveaudit
objectives related to
particularassertionsby
a. Performing
analytical
procedures.
c.
d.
Adheringtoasystemofquality
control.
Preparing auditor working
papers.
Increasingthelevelofdetection
risk.
18. Anentitysincomestatements
weremisstatedduetothe
recordingofjournalentriesthat
involveddebitsandcreditsto
anunusualcombinationof
expenseandrevenueaccounts.
Theauditormostlikelycould
havedetectedthisfraudulent
financialreportingby
a. Tracing a sample of
journal entries to the
generalledger.
b. Evaluating the effectiveness of
internalcontrol.
c. Investigating
the
reconciliations between
controlling accounts
andsubsidiaryrecords.
d. Performing analytical
procedures designed to
disclose differences
fromexpectations.
19. Auditorstrytoidentify
predictablerelationshipswhen
usinganalyticalprocedures.
Relationshipsinvolvingtrans
actionsfromwhichofthe
followingaccountsmostlikely
wouldyieldthehighestlevelof
evidence?
a. Accountsreceivable.
b. Interestexpense.
c. Accountspayable.
d. Travel and entertainment
expense.
20. Analyticalproceduresusedinthe
overallreviewstageofanaudit
generallyinclude
a.
b.
c.
d.
Gathering evidence
concerning account
balances that have not
changedfromtheprior
year.
Retesting control
procedures
that
appeared to be
ineffective during the
assessment of control
risk.
Considering unusual
orunexpectedaccount
balances that were
not
previously
identified.
Performing tests of
transactions
to
corroborate
managements
financial statement
assertions.
21. Whichofthefollowingtendsto
bemostpredictableforpurposes
ofanalyticalproceduresapplied
assubstantivetests?
a. Relationships involving balance
sheetaccounts.
b. Transactions subject to
managementdiscretion.
c. Relationships
involving income
statementaccounts.
d. Data subject to audit testing in
theprioryear.
22. A basic premise underlying the
application of analytical
proceduresisthat
a. Thestudyoffinancial
ratiosisanacceptable
alternative to the
investigation of
unusualfluctuations.
b. Statistical tests of
financial information
may lead to the
discovery of material
misstatements in the
financialstatements.
c. Plausible relationships
among data may
reasonably
be
expected to exist and
continue in the ab
d.
sence of known
conditions to the
contrary.
Theseprocedurescannotreplace
tests of balances and
transactions.
23. Forallauditsoffinancial
statementsmadeinaccordance
withgenerallyacceptedauditing
standards,theuseofanalytical
proceduresisrequiredtosome
extent
a.
b.
c.
d.
Inthe
planningstage
Yes
No
No
Yes
Asa
substantivetest
No
Yes
Yes
No
control
activities are
not
operatingeffectively.
c. Additional tests of details are
required.
d. The communication
with the audit
committee should
berevised.
Inthe
reviewstage
Yes
No
Yes
No
MODULE4RESPONDINGTORISKASSESSMENT
to
26. Whichofthefollowing
comparisonswouldanauditor
mostlikelymakeinevaluatingan
entityscostsandexpenses?
a. The current years
accounts receivable
with the prior years
accountsreceivable.
b. The current years
payroll expense with
theprioryearspayroll
expense.
c. The budgeted current
years sales with the
prioryearssales.
d.
Thebudgetedcurrent
years warranty
expense with the
current
years
contingentliabilities.
27. Tobeeffective,analyticalproceduresinthe
overallreviewstageofanauditengagement
shouldbeperformedby
a. The staff accountant
who performed the
substantive auditing
procedures.
b. The managing partner
who has responsibility
for all audit
engagements at that
practiceoffice.
c. A manager or partner
who has a
comprehensive
knowledge of the
clients business and
industry.
d. TheCPAfirmsquality
controlmanageror
partnerwhohas
responsibilityforthe
firmspeerreview
program.
28. Which of the following is the
bestexampleofasubstantive
test?
a.
b.
d.
Examining a sample of
cashdisbursementstotest
whether expenses have
beenproperlyapproved.
Confirmation of balances of
accountsreceivable.
c. Comparison of
signatures on checks
toalistofauthorized
signers.
Flowchartingoftheclientscash
receiptssystem.
115
a.
b.
c.
d.
Comply
with
generally accepted
auditingstandards.
Attain assurance
about the reliability
of the accounting
system.
Detect material
misstatementsinthe
financialstatements.
Evaluate
whether
managements policies
and
procedures
operatedeffectively.
increase
proportionately with
the auditors reliance
oninternalcontrol.
31. The auditor will most likely
perform extensive tests for
possibleunderstatementof
a. Revenues.
b. Assets.
c. Liabilities.
d. Capital.
32. Whichofthefollowing
procedureswouldanauditormost
likelyperforminauditingthe
statementofcashflows?
a. Comparetheamountsincluded
inthestatementofcashflowsto
similaramountsintheprior
yearsstatementofcashflows.
b.
c.
d.
33. Indeterminingwhether
transactionshavebeenrecorded,
thedirectionoftheaudittesting
shouldbefromthe
a.
b.
c.
d.
Generalledgerbalances.
Adjustedtrialbalance.
Originalsourcedocuments.
Generaljournalentries.
a.
Aminimumoffiveyears.
b. As long as lead
schedules have
d.
relevance to
forthcoming
audits.
c. Until3yearsafter
the client selects
anotherauditor.
Working papers must be
maintainedindefinitely.
36. Whichofthefollowingpairsof
accountswouldanauditormost
likely analyze on the same
workingpaper?
a.
c.
d.
and
accrued interest
payable.
Notes payable and notes
receivable.
Interest income and interest
expense.
the
effectiveness of the
CPA firms quality
controlprocedures.
d. Documentthelevelof
independence
maintained by the
auditor.
38. The permanent file of an
auditors working papers
generallywouldnotinclude
a. Bondindentureagreements.
b. Leaseagreements.
c. Workingtrialbalance.
d. Flowchartofinternalcontrol.
39. Anauditorordinarilyusesa
workingtrialbalance
resemblingthefinancial
statementswithoutfootnotes,
butcontainingcolumnsfor
a. Cash flow increases and
decreases.
b. Auditobjectivesandassertions.
MODULE4RESPONDINGTORISKASSESSMENT
116
c.
d.
42. Whichofthefollowingfactors
mostlikelywouldaffectan
auditorsjudgmentaboutthe
quantity,type,andcontentof
theauditorsworkingpapers?
a. The assessed level of control
risk.
b. The likelihood of a
review by a
concurring (second)
partner.
c. The number of personnel
assignedtotheaudit.
d. Thecontentofthemanagement
representationletter.
Reclassifications
and
adjustments.
Reconciliationsandtickmarks.
the
procedures.
c. The nature and extent of
exceptionsidentified.
d. Whether or not the
client has an
internal audit
function.
41. Whichofthefollowingis
requireddocumentationinan
auditinaccordancewith
generallyacceptedauditing
standards?
a.
b.
c.
Aflowchartornarrative
oftheaccountingsystem
describingtherecording
andclassificationof
transactionsforfinancial
reporting.
44. Whichofthefollowing
documentationisrequiredforan
auditinaccordancewithgenerally
acceptedauditingstandards?
a.
b.
c.
Anauditprogram
settingforthindetailthe
proceduresnecessaryto
accomplishthe
engagements
objectives.
Aplanning
memorandum
establishingthetiming
oftheauditprocedures
andcoordinatingtheas
sistanceofentity
personnel.
Aflowchartoraninternalcontrolquestionnaire
thatevaluatestheeffectivenessoftheentitys
controls.
Aclientengagementletterthatsummarizesthe
timinganddetailsoftheauditorsplannedfield
work.
Anindicationintheworkingpapersthattheac
countingrecordsagreeorreconcilewiththefi
nancialstatements.
The basis for the auditors conclusions when the
assessed level of control risk is at the maximum
levelforallfinancialstatementassertions.
d.
Aninternalcontrol
questionnaire
identifyingcontrolsthat
assurespecific
objectiveswillbe
achieved.
b.
on
consignment and
contingentliabilities.
d. Accounts receivable
and accrued interest
receivable.
without
inspectingtheaccuracy
of the clients bank
reconciliation.
c.
Nothaveaccesstothe
clients cutoff bank
statement.
Be unaware of all the
financial relationships
thatthebankhaswith
theclient.
d.
50. Anauditormostlikelywould
limitsubstantiveaudittestsof
salestransactionswhencontrol
riskisassessedaslowforthe
occurrenceassertionconcerning
salestransactionsandthe
auditorhasalreadygathered
evidencesupporting
a. Opening and closing inventory
balances.
b. Cash receipts and accounts
receivable.
c. Shippingandreceivingactivities.
d. Cutoffsofsalesandpurchases.
d.
Items51and52arebasedonthefollowing:
Theinformationbelowwastakenfromthebanktransferschedulepreparedduringtheauditof
FoxCo.sfinancialstatementsfortheyearendedDecember31,2005.Assumeallchecksare
datedandissuedonDecember30,2005.
MODULE4
Check
no.
101
202
303
404
Bankaccounts
From
National
County
Federal
State
To
Federal
State
American
Republic
51. Whichofthefollowingchecksmight
RESPONDINGTORISKASSESSMENT
Disbursementdate
Receiptdate
Per
Per
Per
Per
books
bank
books
bank
Dec.30
Jan.4
Dec.30
Jan.3
Jan.3
Jan.2
Dec.30
Dec.31
Dec.31
Jan.3
Jan.2
Jan.2
Jan.2
Jan.2
Jan.2
Dec.31
indicatekiting?
a. #101and#303.
117
b.
c.
d.
#202and#404.
#101and#404.
#202and#303.
52.Whichofthefollowingchecks
illustratedeposits/transfersintransitat
December31,2005?
a. #101and#202.
b. #101and#303.
c. #202and#404.
d. #303and#404.
56. Acashshortagemaybeconcealed
53. An auditor should trace bank
bytransportingfundsfromone
transfers for thelastpartof the
locationtoanotherorby
auditperiodandfirstpartofthe
convertingnegotiableassetsto
subsequent period to detect
cash.Becauseofthis,whichof
whether
thefollowingisvital?
a. The cash receipts
a. Simultaneousconfirmations.
journal was held open
b. Simultaneous
bank
forafewdaysafterthe
reconciliations.
yearend.
c. Simultaneousverification.
b. Thelastchecksrecordedbefore
d. Simultaneous surprise cash
the yearend were actually
count.
mailedbytheyearend.
c. Cash balances were overstated 57. Theprimarypurposeofsendingastandard
confirmationrequesttofinancial
becauseofkiting.
institutionswithwhichtheclienthasdone
d. Any unusual payments
businessduringtheyearisto
to or receipts from
a. Detect kiting activities
relatedpartiesoccurred.
thatmayotherwise not
54. Togatherevidenceregardingthe
bediscovered.
balanceperbankinabank
b. Corroborate
reconciliation,anauditorwould
information
examineallofthefollowing
regardingdepositand
except
loanbalances.
a. Cutoffbankstatement.
c. Provide the data
b. Yearendbankstatement.
necessarytopreparea
c. Bankconfirmation.
proofofcash.
d. Generalledger.
d. Request information
about contingent
55. Which of the following cash
liabilitiesandsecured
transfers results in a mis
transactions.
statement of cash at December
31,2005?
58. Anauditorobservesthemailingofmonthly
statementstoaclientscustomersand
BankTransferSchedule
Disbursement
Receipt reviewsevidenceoffollowuponerrors
reportedbythecustomers.Thistestof
controlsmostlikelyisperformedtosupport
Recorded Paidby
Recorded
Transfer
inbooks
bank
inbooks
managementsfinancialstatement
a.
12/31/05 1/4/06
12/31/05 assertion(s)of
b.
c.
d.
1/4/06 1/5/06
12/31/05 1/5/06
1/4/06 1/11/06
12/31/05
12/31/05
1/4/06
a.
b.
c.
d.
Presentation
anddisclosure
Yes
Yes
No
No
Existence
occurrence
Yes
No
Yes
No
Items59and60arebasedonthefollowing:
Check
no.
2020
2021
3217
0659
MilesCompany
BANKTRANSFERSCHEDULE
December31,2005
Bankaccounts
Datedisbursedper
From
To
Amount
Books
Bank
1stNatl.
Suburban
$32,000
12/31
1/5
1stNatl.
Capital
21,000
12/31
1/4
2ndState
Suburban
6,700
1/3
1/5
Midtown
Suburban
5,500
12/30
1/5
Datedepositedper
Books
Bank
12/31
1/3
12/31
1/3
1/3
1/6
12/30
1/3
MODULE4RESPONDINGTORISKASSESSMENT
118
59.Thetickmarkmostlikelyindicatesthat
theamountwastracedtothe
a. December cash disbursements
journal.
b. Outstanding check list of the
applicablebankreconciliation.
c. January cash disbursements
journal.
d. Yearendbankconfirmations.
provide
significant explicit
evidence.
b. Negative confirmation requests
areeffectivewhendetectionrisk
islow.
c.
d.
Unreturned negative
confirmation requests
indicatethatalternative
procedures
are
necessary.
Negativeconfirmationrequests
areeffectivewhen
understatementsofaccount
balancesaresuspected.
62. Whenanauditordoesnotreceive
repliestopositiverequestsfor
yearendaccountsreceivable
confirmations,theauditormost
likelywould
a.
b.
Increasetheassessed
levelofdetectionrisk
forthevaluationand
completeness
assertions.
Ask the client to
contact the customers
to request that the
confirmations be
returned.
Increase the assessed
levelofinherentriskfor
therevenuecycle.
c.
d.
63. Inconfirmingaclientsaccounts
receivableinprioryears,an
auditorfoundthattherewere
manydifferencesbetweenthe
recordedaccountbalancesandthe
confirmationreplies.These
differences,whichwerenot
60.Thetickmarkmostlikelyindicatesthat
theamountwastracedtothe
a. Deposits in transit of the
applicablebankreconciliation.
b. Decembercashreceiptsjournal.
c. Januarycashreceiptsjournal.
d. Yearendbankconfirmations.
a.
b.
c.
d.
misstatements,required
substantialtimetoresolve.In
definingthesamplingunitforthe
currentyearsaudit,theauditor
mostlikelywouldchoose
Individualoverduebalances.
Individualinvoices.
Smallaccountbalances.
Largeaccountbalances.
64. Confirmationismostlikelytobe
arelevantformofevidencewith
regardtoassertionsabout
accountsreceivablewhenthe
auditorhasconcernsaboutthe
receivables
a. Valuation.
b. Classification.
c. Existence.
d. Completeness.
65. An auditor should perform
alternative procedures to
substantiate the existence of
accountsreceivablewhen
a. No reply to a positive
confirmationrequestis
received.
b. Noreply to a negative
confirmation request is
received.
c. Collectibility of the receivables
isindoubt.
d. Pledging of the receivables is
probable.
66. Whichofthefollowing
procedureswouldanauditormost
likelyperformforyearend
accountsreceivablecon
firmationswhentheauditordid
notreceiverepliestosecond
requests?
a.
b.
c.
d.
control
concerningtherevenue
cycle.
Increasetheassessed
levelofdetectionrisk
for the existence
assertion.
Inspecttheshipping
records
documenting the
merchandisesoldto
thedebtors.
67. Inwhichofthefollowing
circumstanceswouldtheuseof
thenegativeformofaccounts
receivableconfirmationmost
likelybejustified?
a. Asubstantialnumber
ofaccountsmaybein
disputeandthe
accountsreceivable
balancearisesfrom
salestoafewmajor
customers.
b. Asubstantialnumber
ofaccountsmaybein
disputeandthe
accountsreceivable
balancearisesfrom
salestomany
customerswithsmall
balances.
c. Asmallnumberof
accountsmaybein
disputeandthe
accountsreceivable
balancearisesfrom
salestoafewmajor
customers.
d. Asmallnumberof
accountsmaybein
disputeandthe
accountsreceivable
balancearisesfrom
salestomany
customerswithsmall
balances.
68. To reduce the risks associated
withacceptingemailresponses
torequestsforconfirmationof
accountsreceivable,anauditor
mostlikelywould
a. Requestthesendersto
mailtheoriginalforms
totheauditor.
b. Examine
subsequent cash
receipts fortheac
countsinquestion.
c. Consider the email
responses to the
d.
confirmations to be
exceptions.
Mail second requests to the e
mailrespondents.
69. Toreducetherisksassociatedwith
acceptingfaxresponsestorequestsfor
confirmationsofaccountsreceivable,an
auditormostlikelywould
a. Examinetheshippingdocuments
that provide evidence for the
existenceassertion.
b. Verify the sources
and contents of the
faxes in telephone
callstothesenders.
c. Considerthefaxestobe
nonresponses and
evaluate them as
unadjusteddifferences.
d. Inspectthefaxesfor
forgeriesoralterations
andconsiderthemtobe
acceptableifnoneare
noted.
70. Inauditingaccountsreceivable,
the negative form of
confirmation request most
likelywouldbeusedwhen
a. Thetotalrecordedamountof
accountsreceivableisimmaterial
tothefinancialstatementstaken
asawhole.
b.
positive
confirmation requests
wereinadequate.
MODULE4RESPONDINGTORISKASSESSMENT
c.
Recipientsarelikelytoreturnpositiveconfirma75.Anauditormostlikelywouldmake
inquiriesofpro
tionrequestswithoutverifying
ductionandsalespersonnelconcerning
theaccuracyoftheinformation.
possibleobsoleteorslowmoving
d. The combined assessed
inventorytosupportmanagements
financialstatementassertionof
levelofinherentriskand
a. Valuation.
control risk relative to
b. Rights.
accounts receivable is
c. Existence.
low.
d. Presentation.
71. Underwhichofthefollowingcircumstances
wouldtheuseoftheblankformof
confirmationsofaccountsreceivablemost
likelybepreferabletopositive
confirmations?
a. Therecipientsarelikelytosigntheconfirmations76.Whileobservingaclientsannual
physicalinventory,
withoutdevotingproper
receivabletoencouragetimely
attentiontothem.
considerationbytherecipients?
b. Subsequent
cash
a. Thisisnotarequest
receipts are unusually
forpayment;
difficulttoverify.
remittancesshouldnot
c. Analytical
besenttoourauditors
procedures indicate
intheenclosed
that few exceptions
envelope.
areexpected.
b. Reportanydifferences
d. Thecombinedassessed
ontheenclosed
level of inherent risk
statementdirectlytoour
andcontrolriskislow.
auditors;noreplyis
necessaryifthisamount
72. In confirming accounts
agreeswithyour
receivable,anauditordecidedto
records.
confirm customers account
balances rather than individual
c. Ifyoudonotreport
invoices.Whichofthefollowing
anydifferenceswithin
most likely would be included
fifteendays,itwillbe
with the clients confirmation
assumedthatthis
letter?
statementiscorrect.
a. An auditorprepared
d. Thefollowinginvoices
letter explaining thata
havebeenselectedfor
nonresponse may
confirmationand
causeaninferencethat
representamountsthat
the account balance is
areoverdue.
correct.
74. Which of the following
b. Aclientpreparedletter
strategies most likely could
remindingthecustomer
improve the response rate of
thatanonresponsewill
the confirmation of accounts
causeasecondrequest
receivable?
tobesent.
a. Includingalistofitems
c. Anauditorprepared
or invoices that
letterrequestingthecus
constitute the account
tomertosupplymissing
balance.
andincorrect
b. Restricting the
informationdirectlyto
selection ofaccounts
theauditor.
to be confirmed to
d. A clientprepared
thosecustomerswith
statement of account
relatively large
showing the details of
balances.
the customers account
c.
Requestingcustomersto
balance.
respondtotheconfirma
73. Whichofthefollowingstatementswould
tionrequestsdirectlyto
theauditorbyfaxore
anauditormostlikelyaddtothenegative
mail.
formofconfirmationsofaccounts
119
d.
Notifyingtherecipients
that second requests
will be mailed if they
fail to respond in a
timelymanner.
anauditorrecordedtestcountsforseveral
itemsandnoticedthatcertaintestcounts
werehigherthantherecordedquantities
intheclientsperpetualrecords.This
situationcouldbetheresultoftheclients
failuretorecord
a. Purchasediscounts.
b. Purchasereturns.
c. Sales.
d. Salesreturns.
77. Togainassurancethatall
inventoryitemsinaclients
inventorylistingscheduleare
valid,anauditormostlikely
wouldtrace
a. Inventorytagsnoted
duringtheauditors
observationtoitems
listedintheinventory
listingschedule.
b. Inventorytagsnoted
duringtheauditors
observationtoitems
listedinreceiving
reportsandvendors
invoices.
c. Itemslistedinthe
inventorylisting
scheduletoinventory
tagsandtheauditors
recordedcountsheets.
d. Items listed in
receiving reports and
vendors invoices to
the inventory listing
schedule.
78. Tomeasurehoweffectivelyan
entityemploysitsresources,an
auditorcalculatesinventory
turnoverbydividingaverage
inventoryinto
a. Netsales.
b. Costofgoodssold.
c. Operatingincome.
d. Grosssales.
79. Whichofthefollowing
auditingproceduresmostlikely
wouldprovideassuranceabout
amanufacturingentitys
inventoryvaluation?
a. Testing the entitys
computationofstandard
overheadrates.
b. Obtaining confirmation of
inventories pledged under loan
agreements.
c. Reviewing shipping
and receiving cutoff
procedures for
inventories.
d. Tracingtestcounts to
the entitys inventory
listing.
80. A client maintains perpetual
c.
d.
Applygrossprofit
tests to ascertain
the
rea
sonablenessofthe
physicalcounts.
120
MODULE4RESPONDINGTORISKASSESSMENT
81. Anauditorconcludedthatno
excessivecostsforidleplant
werechargedtoinventory.This
conclusionmostlikelyrelatedto
theauditorsobjectivetoobtain
evidenceaboutthefinancial
statementassertionsregarding
inventory,includingpresentation
anddisclosureand
a. Valuation.
b. Completeness.
c. Existence.
d. Rights.
82. Anauditorselecteditemsfortestcounts
whileobservingaclientsphysical
inventory.Theauditorthentracedthetest
countstotheclientsinventorylisting.This
proceduremostlikelyobtainedevidence
concerningmanagementsassertionof
a. Rights.
b. Completeness.
c. Existence.
d. Valuation.
83. An auditor most likely would
analyze inventory turnover
rates to obtain evidence
concerning managements as
sertionsabout
a. Existence.
b. Rights.
c. Presentation.
d. Valuation.
84. An auditor usually examines
receiving reports to support
entriesinthe
a. Voucher register and sales
returnsjournal.
b. Sales journal and sales returns
journal.
c. Voucher register and sales
journal.
d. Checkregisterandsalesjournal.
85. When auditing inventories,
anauditorwould leastlikely
verifythat
a. The
financial
statement presentation
of inventories is
appropriate.
b. Damagedgoodsand
obsolete items have
been properly
accountedfor.
c. All inventory owned
by the client is on
hand at the time of
thecount.
d. The client has used proper
inventorypricing.
86. An auditor who physically
examinessecuritiesshouldinsist
that a client representative be
presentinorderto
a. Detectfraudulentsecurities.
b. Lend authority to the auditors
directives.
c. Acknowledge the receipt of
securitiesreturned.
d. Coordinate the return
of securities to the
properlocations.
87. Inestablishingtheexistenceand
ownershipofalongterm
investmentintheformof
publiclytradedstock,anauditor
shouldinspectthesecuritiesor
a. Correspond with the
investee company to
verify the number of
sharesowned.
b. Inspect the audited
financial statements of
theinvesteecompany.
c. Confirm the number of shares
owned that are held by an
independentcustodian.
d. Determine that the
investmentiscarried
at the lower of cost
ormarket.
88. Whenanauditorisunableto
inspectandcountaclients
investmentsecuritiesuntilafterthe
balancesheetdate,
thebankwherethesecuritiesareheldin
asafedepositboxshouldbeaskedto
a. Verifyanydifferences
betweenthecontentsof
theboxandthebalances
intheclientssubsidiary
ledger.
b. Providealistof
securitiesaddedand
removedfromthebox
betweenthebalance
sheetdateandthe
securitycountdate.
c. Confirmthattherehas
been no accesstothe
box between the
balancesheetdateand
the securitycount
date.
d. Countthesecuritiesin
the boxso the auditor
will have an
independent direct
verification.
89. Intestinglongterminvestments,
an auditor ordinarily would use
analyticalprocedurestoascertain
thereasonablenessofthe
a. Completeness of recorded
investmentincome.
b. Classification
betweencurrentand
noncurrent
portfolios.
c. Valuation of marketable equity
securities.
d. Existence of unrealized
gains or losses in the
portfolio.
90. Analysisofwhichaccountis
least likely to reveal
evidencerelatingtorecorded
retirementofequipment?
a. Accumulateddepreciation.
b. Insuranceexpense.
c. Property,plant,andequipment.
d. Purchasereturnsandallowances.
91. Whichofthefollowing
explanationsmostlikelywould
satisfyanauditorwhoquestions
managementaboutsignificant
debitstotheaccumulated
depreciationaccounts?
a.
b.
d.
The
estimated
remaining useful lives
of plant assets were
revisedupward.
Plant assets were retired during
theyear.
c. The prior years
depreciation expense
was
erroneously
understated.
Overhead allocations were
revisedatyearend.
equipment
subsidiaryledger.
d. Scanthegeneral
journalforunusual
equipmentadditions
andexcessivedebits
torepairsand
maintenanceexpense.
93. An auditor analyzes repairs and
maintenance accounts primarily
toobtainevidenceinsupportof
theauditassertionthatall
a. Noncapitalizable
expendituresforrepairs
andmaintenancehave
beenrecordedinthe
properperiod.
b. Expenditures for
property
and
equipmenthavebeen
recorded in the
properperiod.
c. Noncapitalizable
expendituresfor
repairsand
maintenancehave
beenproperly
chargedtoexpense.
MODULE4RESPONDINGTORISKASSESSMENT
d.
Expenditures
property
equipment have
been charged
expense.
for
and
not
to
for
uncollectible ac
counts.
b. Appropriateness of
physical inventory
observation
procedures.
c. Existenceofobsoletemachinery.
d. Deferral
of
procurementofcertain
necessary insurance
coverage.
95. TreetopCorporationacquireda
buildingandarrangedmortgage
financingduringtheyear.
Verificationoftherelated
mortgageacquisitioncostswould
beleastlikelytoincludean
examinationoftherelated
a. Deed.
b. Canceledchecks.
c. Closingstatement.
d. Interestexpense.
96. Intestingplantandequipmentbalances,an
auditormayinspectnewadditionslistedon
theanalysisofplantandequipment.This
procedureisdesignedtoobtainevidence
concerningmanagementsassertionsof
a.
b.
c.
d.
Existenceor
occurrence
Yes
Yes
No
No
Presentationand
disclosure
Yes
No
Yes
No
97. Inauditingintangibleassets,an
auditormostlikelywould
revieworrecompute
amortizationanddetermine
whethertheamortizationperiod
isreasonableinsupportof
managementsfinancial
statementassertionof
a. Valuationorallocation.
b. Existenceoroccurrence.
c. Completeness.
d. Rightsandobligations.
98. Whenauditingprepaidinsurance,
anauditordiscoversthatthe
originalinsurancepolicyonplant
equipmentisnotavailablefor
inspection.Thepolicysabsence
mostlikelyindicatesthe
a.
b.
c.
d.
121
possibilityofa(n)
Insurance premium due but not
recorded.
Deficiency in the coinsurance
provision.
Lienontheplantequipment.
Understatement of insurance
expense.
b.
c.
prenumberedpurchaseordersare
usedandaccountedfor.
Receivingtheclientsmail,
unopened,forareasonable
periodoftimeaftertheyearend
tosearchforunrecorded
vendorsinvoices.
Vouchingselectedentriesinthe
accounts payable subsidiary
ledger to purchase orders and
receivingreports.
d.
Confirming
accounts payable
balances with
known suppliers
who have zero
balances.
103. Inauditingaccountspayable,an
auditorsproceduresmostlikely
would focus primarily on
managementsassertionof
a. Existence.
b. Presentationanddisclosure.
c. Completeness.
d. Valuation.
104. WhenaCPAobservesthatthe
recordedinterestexpenseseems
tobeexcessiveinrelationtothe
balanceinthebondspayable
account,theCPAmightsuspect
that
a. Discount on bonds payable is
understated.
b. Bondspayableareunderstated.
c. Bondspayableareoverstated.
d. Premium on bonds payable is
overstated.
105. Anauditormostlikelywould
inspectloanagreementsunder
whichanentitysinventoriesare
pledgedtosupport
managementsfinancial
statementassertionof
a. Presentationanddisclosure.
b. Valuationorallocation.
c. Existenceoroccurrence.
d. Completeness.
MODULE4RESPONDINGTORISKASSESSMENT
122
b.
c.
d.
Examine
documentationofassets
purchased with bond
proceedsforliens.
Compare interest
expensewiththebond
payable amount for
reasonableness.
Confirm the existence
of individual bond
holdersatyearend.
107. Theauditorcanbestverifya
clients bond sinking fund
transactions and yearend
balanceby
a. Confirmation with
individual holders of
retiredbonds.
b. Confirmation with the bond
trustee.
c. Recomputationof
interestexpense,
interestpayable,and
amortizationofbond
discountorpremium.
d. Examination and count of the
bondsretiredduringtheyear.
108. An auditor usually obtains
evidence of stockholders
equity transactions by
reviewingtheentitys
a. Minutes of board of directors
meetings.
b. Transferagentsrecords.
c. Canceledstockcertificates.
d. Treasurystockcertificatebook.
109. Whencontrolriskisassessedas
lowforassertionsrelatedto
payroll,substantivetestsof
payrollbalancesmostlikely
wouldbelimitedtoapplying
analyticalproceduresand
a. Observing the distribution of
paychecks.
b. Footing and crossfooting the
payrollregister.
c. Inspectingpayrolltaxreturns.
d. Recalculatingpayrollaccruals.
110. Whichofthefollowing
circumstancesmostlikelywould
causeanauditortosuspectan
employeepayrollfraudscheme?
a. There are significant
unexplainedvariances
between standard
andactuallaborcost.
b. Payroll checks are
disbursed by the
same employee
eachpayday.
c. Employee time cards
d.
are approved by
individual
departmental
supervisors.
Aseparatepayrollbank
account is maintained
onanimprestbasis.
the
transactionwiththe
Secretary of State
in the state of
incorporation.
b. Verify the existence
of option holders in
the entitys payroll
records or stock
ledgers.
c. Determine
that
sufficient treasury
stock is available to
cover any new stock
issued.
d. Trace
the
authorizationforthe
transactiontoavote
of the board of
directors.
a.
113. Duringanauditofanentitys
stockholdersequityaccounts,
theauditordetermineswhether
therearerestrictionsonretained
earningsresultingfromloans,
agreements,orstatelaw.This
auditproceduremostlikelyis
intendedtoverifymanagements
assertionof
a. Existenceoroccurrence.
b. Completeness.
c. Valuationorallocation.
d. Presentationanddisclosure.
114. Whenaclientcompanydoesnot
maintainitsownstockrecords,the
auditorshouldobtainwritten
confirmationfromthetransferagent
andregistrarconcerning
a.
b.
c.
retained
earningstoaccountfor
a twoforone stock
split.
b. Approval of the
adjustment to the
beginningbalanceasa
result of a writedown
of an account re
ceivable.
c. Authorizationforbothcashand
stockdividends.
d. Gain or loss resulting
from disposition of
treasuryshares.
116. An auditor most likely would perform
substantive tests of details on payroll
transactionsandbalanceswhen
b.
c.
d.
Cutofftestsindicatea
substantial amount of
accrued payroll
expense.
The assessed level of
control risk relative to
payroll transactions is
low.
Analyticalprocedures
indicate unusual
fluctuations in
recurring payroll
entries.
Accruedpayrollexpense
consistsprimarilyofun
paidcommissions.
117. Anauditorusuallyteststhereasonableness
ofdividendincomefrominvestmentsin
publiclyheldcompaniesbycomputingthe
amountsthatshouldhavebeenreceivedby
referringto
a. Dividend record
books produced by
investment advisory
services.
b. Stock indentures
publishedbycorporate
transferagents.
c. Stock
ledgers
maintained
by
independent regis
trars.
d. Annual
audited
financial statements
issued by the investee
companies.
118. The most likely risk
involvedwithabillandhold
transaction at yearend is
a(n)
a. Accruedliabilitymay
be overstated as of
yearend.
b. Buyer may have made
an absolute purchase
commitment.
c. Sale
may
inappropriately have
been recorded as of
yearend.
d. Buyer may have
assumed the risk and
reward of the
purchasedproduct.
MODULE4RESPONDINGTORISKASSESSMENT
119. Whichofthefollowing
accountsisthepracticeof
channelstuffingforsales
mostlikelytomostdirectlyaf
fect,andtherebyresultin
additionalauditprocedures?
a. Accruedliabilities.
b. Allowanceforsalesreturns.
c. Cash.
d. Marketableinvestments.
120. Recordedentriesinwhichof
thefollowingaccountsare
mostlikelytorelatetothe
property,plant,andequipment
completenessassertion?
a. Allowancefordoubtfulaccounts.
b. Marketablesecurities.
c. Property,plant,andequipment.
d. Repairs and maintenance
expense.
121. For which of the following
mattersshouldanauditorobtain
written
management
representations?
a. Managements cost
benefit justifications
for not correcting
internal
control
weaknesses.
b. Managements
knowledgeoffuture
plans that may
affect the price of
theentitysstock.
c. Managements
compliancewith
contractual
agreementsthatmay
affectthefinancial
statements.
d. Managements
acknowledgment of
itsresponsibilityfor
employees
violationsoflaws.
122. Towhichofthefollowing
matterswouldmaterialitylimits
notapplyinobtainingwritten
managementrepresentations?
a. The availability of
minutes
of
stockholders and
directorsmeetings.
b. Lossesfrompurchase
commitments at
prices in excess of
marketvalue.
c. The disclosure of
compensating balance
arrangements
involving related
parties.
d.
123
Reductions of obsolete
inventory to net
realizablevalue.
123. Thedateofthemanagement
representation letter should
coincidewiththedateofthe
a. Balancesheet.
b. Latest interim financial
information.
c. Auditorsreport.
d. Latestrelatedpartytransaction.
124. Which of the following matters
would an auditor most likely
include in a management
representationletter?
a. Communications with
the audit committee
concerning
weaknessesininternal
control.
b. Thecompletenessand
availabilityofminutes
of stockholders and
directorsmeetings.
c. Plans to acquire or merge with
other entities in the subsequent
year.
d. Managements
acknowledgment of
itsresponsibilityfor
the detection of
employeefraud.
125. Thecurrentchiefexecutiveand
financialofficershaveonlybeen
employedbyABCCompanyfor
thepastfivemonthsofyear2.
ABCCompanyispresenting
comparativefinancialstatements
onYears1and2,bothofwhich
wereauditedbyWilliamJones,
CPA.Forwhichyear(s)should
Jonesobtainwritten
representationsfromthesetwo
individuals?
128. Awrittenrepresentationfromaclients
managementwhich,amongothermatters,
a.
acknowledgesresponsibilityforthefair
b.
presentationoffinancialstatements,should
c.
normallybesignedbythe
d.
a. Chief executive officer
and the chief financial
126. Whichofthefollowing
officer.
statementsordinarilyisincluded
b. Chief financial
amongthewrittenclient
officer and the
representationsobtainedbythe
chairman of the
auditor?
boardofdirectors.
a. Compensatingbalances
c.
Chairman of the audit
andotherarrangements
committeeoftheboard
involvingrestrictionson
ofdirectors.
cashbalanceshavebeen
d.
Chief executive officer,
disclosed.
the chairman of the
b. Management acknowledges
board of directors, and
responsibilityforillegalactions
theclientslawyer.
committedbyemployees.
c. Sufficientauditevidence
129. Alimitationonthescopeofthe
hasbeenmadeavailable
auditorsexaminationsufficient
topermittheissuanceof
toprecludeanunqualified
anunqualifiedopinion.
opinionwillalwaysresultwhen
Year1
No
No
Yes
Yes
d.
Year2
No
Yes
No
Yes
Management
acknowledges that
therearenomaterial
weaknesses in the
internalcontrol.
127. Whenconsideringtheuseof
managementswritten
representationsasauditevidence
aboutthecompletenessassertion,
anauditorshouldunderstandthat
suchrepresentations
a. Complement,butdonot
replace,substantivetests
designed to support the
assertion.
b. Constitutesufficient
evidencetosupportthe
assertionwhen
consideredin
combinationwithreli
anceoninternalcontrol.
c. Are not part of the
audit
evidence
considered to support
theassertion.
d. Replace reliance on internal
control as evidence to support
theassertion.
management
a. Prevents the auditor
from reviewing the
working papers of the
predecessorauditor.
b. Engages the auditor after the
yearend physical inventory
countiscompleted.
c. Failstocorrecta
significantdeficiencyof
internalcontrolthathad
beenidentifiedduring
theprioryearsaudit.
d. Refuses to furnish a
management
representationletterto
theauditor.
MODULE4RESPONDINGTORISKASSESSMENT
124
c.
d.
Thepossibilityofa
misunderstanding
concerning
managements
responsibilityforthe
financialstatements.
The scope of an
auditors procedures
concerning relatedparty
transactions
and
subsequentevents.
concerning
noncompliance with, or
deficienciesin,financialreporting
practices that could have a
material effect on the financial
statements. The foregoing
passageismostlikelyfroma
a. Reportoninternalcontrol.
b. Specialreport.
c. Management representation
letter.
d. Letterforunderwriters.
132. Which of the following
statementsiscorrectconcerning
anauditorsuseoftheworkofa
specialist?
a. Theworkofa
specialistwhois
relatedtotheclient
maybeacceptable
undercertaincircum
stances.
b. If an auditor
believes that the
determinations
made by a
specialist are
unreasonable, only
a qualified opinion
maybeissued.
c. Ifthereisamaterial
differencebetweena
specialistsfindings
andtheassertionsinthe
financialstatements,
onlyanadverseopinion
maybeissued.
d. Anauditormaynotuse
aspecialistinthedeter
minationofphysical
characteristicsrelating
toinventories.
133. Inusingtheworkofaspecialist,
anauditormayrefertothe
specialistintheauditorsreport
if,asaresultofthespecialists
findings,theauditor
a. Becomesawareof
conditionscausing
substantialdoubtabout
b.
theentitysabilityto
continueasagoing
concern.
Desirestodisclosethespecialists
findings,whichimplythatamore
thoroughauditwasperformed.
c.
d.
Is able to corroborate
another specialists
earlier findings that
were consistent with
managements
representations.
Discovers significant
deficiencies in the
design of the entitys
internal control that
management does not
correct.
Theauditorshouldobtain
an understanding of the
methodsandassumptions
usedbythespecialist.
135. Inusingtheworkofaspecialist,
anauditorreferredtothe
specialistsfindingsinthe
auditorsreport.Thiswouldbean
appropriatereportingpracticeif
the
a. Clientisnotfamiliar
withtheprofessional
certification,personal
reputation,orparticular
competenceofthe
specialist.
b.
c.
d.
Auditor,asaresultof
thespecialists
findings,addsan
explanatoryparagraph
emphasizingamatter
regardingthe
financialstatements.
136. Inusingtheworkofaspecialist,
anunderstandingshouldexist
amongtheauditor,theclient,and
thespecialistastothenatureof
thespecialistswork.The
documentationofthis
understandingshouldcover
a. Astatementthatthe
specialistassumesno
responsibilitytoupdate
thespecialistsreportfor
futureeventsor
circumstances.
b. The conditions under
which a division of
responsibility may be
necessary.
c. The specialists
understandingofthe
auditors
corroborativeuseof
the specialists
findings.
d. Theauditorsdisclaimerasto
whetherthespecialistsfindings
corroboratetherepresentationsin
thefinancialstatements.
137. Whichofthefollowingis not a
specialist upon whose work an
auditormayrely?
a. Actuary.
b. Appraiser.
c. Internalauditor.
d. Engineer.
138. Alawyersresponsetoan
auditorsinquiryconcerning
litigation,claims,andassessments
maybelimitedtomattersthatare
consideredindividuallyor
a.
b.
c.
d.
collectivelymaterialtothe
clientsfinancialstatements.
Whichpartiesshouldreachan
understandingonthelimitsof
materialityforthispurpose?
The auditor and the clients
management.
Theclientsauditcommitteeand
thelawyer.
Theclientsmanagementandthe
lawyer.
Thelawyerandtheauditor.
139. Therefusalofaclientsattorney
toprovideinformationrequested
in an inquiry letter generally is
considered
a.
b.
c.
d.
Groundsforanadverseopinion.
Alimitationonthescopeofthe
audit.
Reason to withdraw from the
engagement.
Equivalent to a significant
deficiency.
140. Whichofthefollowingisan
auditprocedurethatanauditor
mostlikelywouldperform
concerninglitigation,claims,
andassessments?
a. Requesttheclients
lawyertoevaluate
whethertheclients
pendinglitigation,
claims,andas
sessmentsindicatea
goingconcern
problem.
b. Examinethelegal
documentsintheclients
lawyerspossession
concerninglitigation,
claims,andassessments
towhichthelawyerhas
devotedsubstantive
attention.
c. Discuss
with
management
its
policies and proce
dures adopted for
evaluating
and
accounting
for
litigation, claims, and
assessments.
d.
MODULE4RESPONDINGTORISKASSESSMENT
141. Theprimaryreasonanauditor
requestslettersofinquirybe
senttoaclientsattorneysisto
providetheauditorwith
a. The probable
outcomeofasserted
claims andpending
or threatened
litigation.
b. Corroborationofthe
informationfurnished
bymanagementabout
litigation,claims,and
assessments.
c.
Theattorneysopinions
oftheclientshistorical
experiences in recent
similarlitigation.
d.
Adescriptionand
evaluationoflitigation,
claims,andassessments
thatexistedatthe
balancesheetdate.
142. Whichofthefollowingisnotan
auditprocedurethatthe
independentauditorwould
performconcerninglitigation,
claims,andassessments?
a. Obtainassurancefrom
managementthatithasdisclosed
allunassertedclaimsthatthe
lawyerhasadvisedareprobable
ofassertionandmustbedis
closed.
b. Confirm directly with
theclientslawyerthat
all claims have been
recorded in the
financialstatements.
c. Inquireofanddiscuss
withmanagementthe
policiesandprocedures
adoptedforidentifying,
evaluating,and
accountingfor
litigation,claims,and
assessments.
d. Obtainfrom
managementa
descriptionand
evaluationof
litigation,claims,and
assessmentsexisting
atthebalancesheet
date.
143. The scope of an audit is not
restricted when an attorneys
responsetoanauditorasaresult
of a clients letter of audit
inquirylimitstheresponseto
a. Matters to which the
attorney has given
substantive attention
in the form of legal
b.
c.
d.
representation.
125
An evaluation of the
likelihood of an
unfavorable outcome of
the matters disclosed by
theentity.
The
attorneys
opinionoftheentitys
historical experience
in recent similar
litigation.
The probable
outcomeofasserted
claims andpending
or threatened
litigation.
144. ACPAhasreceivedan
attorneysletterinwhichno
significantdisagreementswith
theclientsassessmentsof
contingentliabilitieswerenoted.
Theresignationoftheclients
lawyershortlyafterreceiptofthe
lettershouldalerttheauditorthat
a. Undisclosed unasserted claims
mayhavearisen.
b. Theattorneywas
unabletoforma
conclusionwith
respecttothe
significanceof
litigation,claims,
andassessments.
c. The auditor must
begin a completely
new examination
of contingent
liabilities.
d. An adverse opinion will be
necessary.
145. Whichofthefollowing
statementsextractedfroma
clientslawyersletter
concerninglitigation,claims,
andassessmentsmostlikely
wouldcausetheauditorto
requestclarification?
a. I believe that the
possible liability to
the company is
nominalinamount.
b. I believe that the
action can be settled
for less than the
damagesclaimed.
6. Ibelievethattheplaintiffscase
againstthecompanyiswithout
merit.
7. Ibelievethatthecompanywill
be able to defend this action
successfully.
146.Whenauditingthefairvalueofan
assetorliability,valuationissues
ordinarilyariseatthepointof
a.
b.
c.
d.
Initial
recording
Yes
Yes
No
No
Subsequentto
initialrecording
Yes
No
Yes
No
147. Whichofthefollowingisleast
likelytobeanapproach
followedwhenauditingthefair
valuesofassetsandliabilities?
a. Review and test
managements process
ofvaluation.
b. Confirm valuations
with audit committee
members.
c. Independently develop
anestimateofthevalue
oftheaccount.
d. Review subsequent events
relatingtotheaccount.
148. Whichofthefollowing
auditingproceduresmost
likelywouldassistanauditor
inidentifyingrelatedparty
transactions?
a. Inspecting
correspondence with
lawyers for evidence
of
unreported
contingentliabilities.
b.
Vouching accounting
records for recurring
transactions recorded
just after the balance
sheetdate.
c.
Reviewing
confirmations of loans
receivableandpayable
for indications of
guarantees.
Performing analytical
procedures
for
d.
indications of possible
financialdifficulties.
149. Afterdeterminingthatarelated
party transaction has, in fact,
occurred,anauditorshould
a. Addaseparateparagraphtothe
auditors standard report to
explainthetransaction.
b. Performanalytical
procedurestoverify
whethersimilar
transactionsoccurred,
butwerenotre
corded.
c. Obtain
an
understanding of the
businesspurposeofthe
transaction.
d. Substantiatethatthe
transaction was
consummated on
terms equivalent to
an armslength
transaction.
150. When auditing relatedparty
transactions, an auditor places
primaryemphasison
a. Ascertainingtherights
and obligations of the
relatedparties.
b. Confirmingtheexistenceofthe
relatedparties.
c. Verifying the valuation
of the relatedparty
transactions.
d. Evaluating the
disclosure of the
relatedparty
transactions.
151. Which of the following
statementsiscorrectconcerning
relatedpartytransactions?
a. Intheabsenceofevidencetothe
contrary,relatedparty
transactionsshouldbeassumed
tobeoutsidetheordinarycourse
ofbusiness.
b. An auditor should
determine whether a
particular transaction
would have occurred if
thepartieshadnotbeen
related.
MODULE4RESPONDINGTORISKASSESSMENT
126
d.
a.
b.
Anauditorshould
substantiatethat
relatedparty
transactionswere
consummatedonterms
equivalenttothosethat
prevailinarmslength
transactions.
The audit procedures
directed
toward
identifying relatedparty
transactions should
include considering
whethertransactionsare
occurring, but are not
being given proper
accountingrecognition.
152. Anauditormostlikelywouldmodifyan
unqualifiedopinioniftheentitysfinancial
statementsincludeafootnoteonrelated
partytransactions
a. Disclosing loans to
relatedpartiesatinterest
ratessignificantlybelow
prevailingmarketrates.
b. Describing
an
exchangeofrealestate
forsimilarpropertyin
anonmonetaryrelated
partytransaction.
c.
d.
armslength
transaction.
Presentingthedollar
volumeofrelatedparty
transactionsandthe
effectsofanychangein
themethodof
establishingtermsfrom
priorperiods.
153. Whichofthefollowing
procedureswouldanauditor
mostlikelyperforminobtaining
evidenceaboutsubsequent
events?
a. Determine thatchanges
in employee pay rates
after yearend were
properlyauthorized.
b. Recompute
depreciation charges
for plant assets sold
afteryearend.
c.
Investigatechangesin
longterm
debt
occurring after year
end.
154. Whichofthefollowingeventsoccurring
aftertheissuanceofanauditorsreport
mostlikelywouldcausetheauditortomake
furtherinquiriesaboutthepreviouslyissued
financialstatements?
a. Anuninsurednaturaldisaster
occursthatmayaffectthe
entitysabilitytocontinueasa
goingconcern.
b. A contingency is
resolved that had been
disclosedinthe audited
financialstatements.
c.
New information is
discovered concerning
undisclosed
lease
transactions of the
auditedperiod.
d.
A subsidiary is sold
that accounts for 25%
of the entitys
consolidated net
income.
155. ZeroCorp.sufferedalossthatwouldhave
amaterialeffectonitsfinancialstatements
onanuncollectibletradeaccountreceivable
duetoacustomersbankruptcy.This
occurredsuddenlyduetoanaturaldisaster
tendaysafterZerosbalancesheetdate,but
onemonthbeforetheissuanceofthe
financialstatementsandtheauditors
report.Underthesecircumstances,
a.
b.
c.
d.
The
financial
statements
shouldbe
adjusted
Yes
Yes
No
No
Theevent
requiresfinancial
statement
disclosure,but
noadjustment
No
No
Yes
Yes
Theauditors
reportshould
bemodified
foralackof
consistency
No
Yes
Yes
No
156. Afteranauditreportcontainingan
unqualifiedopiniononanonissuer
(nonpublic)clientsfinancialstatements
wasissued,theclientdecidedtosellthe
sharesofasubsidiarythataccountsfor
30%ofitsrevenueand25%ofitsnet
income.Theauditorshould
a. Determinewhetherthe
informationisreliable
and,ifdeterminedto
bereliable,request
thatrevisedfinancial
statementsbeissued.
b. Notifytheentitythatthe
auditorsreportmaynolonger
beassociatedwiththefinancial
statements.
c. Describetheeffectsof
thissubsequently
discovered
informationina
communicationwith
personsknowntobe
relyingonthefinancial
statements.
d. Take no actionbecause
the auditor has no
obligationtomakeany
furtherinquiries.
157. A client acquired 25% of its
outstanding capital stock after
yearendandpriortocompletion
of theauditorsfieldwork.The
auditorshould
a. Advise management to
adjustthebalancesheet
to reflect the
acquisition.
b.
Issueproformafinancial
statements giving effect
totheacquisitionasifit
hadoccurredatyearend.
c.
Advise management to
disclose the acquisition
in the notes to the
financialstatements.
Disclose
the
acquisition in the
opinion paragraph of
theauditorsreport.
d.
158. Whichofthefollowing
procedureswouldanauditor
mostlikelyperformtoobtain
evidenceabouttheoccurrenceof
subsequentevents?
a. Confirmingasampleof
material accounts
receivable established
b.
c.
d.
afteryearend.
Comparing the
financialstatements
being reported on
with those of the
priorperiod.
Investigating personnel
changes in the
accounting department
occurringafteryearend.
Inquiringastowhether
any
unusual
adjustments were
madeafteryearend.
Communicate
material weaknesses
ininternalcontrolto
the clients audit
committee.
d.
160. OnFebruary25,aCPAissuedan
auditorsreportexpressingan
unqualifiedopiniononfinancial
statementsfortheyearended
January31.OnMarch2,theCPA
learnedthatonFebruary11,the
entityincurredamateriallosson
anuncollectibletradereceivable
asaresultofthedeteriorating
financialconditionoftheentitys
principalcustomerthatledtothe
customer'sbankruptcy.
Managementthenrefusedto
adjustthefinancialstatementsfor
thissubsequentevent.TheCPA
determinedthattheinformationis
reliableandthatthereare
creditorscurrentlyrelyingonthe
financialstatements.TheCPAs
nextcourseofactionmostlikely
wouldbeto
MODULE4RESPONDINGTORISKASSESSMENT
a.
b.
Notifytheentitys
creditorsthatthe
financialstatementsand
therelatedauditors
reportshouldnolonger
bereliedon.
Notifyeachmemberofthe
entitysboardofdirectorsabout
managementsrefusaltoadjust
thefinancialstatements.
c. Issue revised financial
statements
and
distributethemtoeach
creditor known to be
relyingonthefinancial
statements.
d. Issuearevisedauditors
report and distribute it
to each creditor known
to be relying on the
financialstatements.
127
161. Anauditorisconsideringwhether
theomissionofasubstantive
procedureconsiderednecessary
atthetimeofanauditmayimpair
theauditorspresentabilityto
supportthepreviouslyexpressed
opinion.Theauditorneednot
applytheomittedprocedureifthe
a. Financialstatementsand
auditorsreportwerenot
distributedbeyond
managementandthe
boardofdirectors.
b. Auditors previously expressed
opinion was qualified because
ofadeparturefromGAAP.
c. Results of other
procedures that were
applied tend to
compensate for the
procedureomitted.
d.
Omission is due to
unreasonable delays by
client personnel in
providing data on a
timelybasis.
162. OnMarch15,2002,Kent,CPA,
issuedanunqualifiedopinionon
aclientsauditedfinancial
statementsfortheyearended
December31,2001.OnMay4,
2002,Kentsinternalinspection
programdisclosedthat
engagementpersonnelfailedto
observetheclientsphysical
inventory.Omissionofthis
procedureimpairsKentspresent
abilitytosupporttheunqualified
opinion.Ifthestockholdersare
currentlyrelyingontheopinion,
Kentshouldfirst
a. Advise management to
b.
c.
d.
disclose to the
stockholders that
Kents unqualified
opinion should not be
reliedon.
Undertaketoapply
alternativeprocedures
thatwouldprovidea
satisfactorybasisforthe
unqualifiedopinion.
Reissuetheauditors
reportandaddan
explanatoryparagraph
describingthedeparture
fromgenerally
acceptedauditing
standards.
Compensateforthe
omittedprocedureby
performingtestsof
controlstoreduceaudit
risktoasufficiently
lowlevel.
163. Sixmonthsafterissuingan
unqualifiedopiniononaudited
financialstatements,anauditor
discoveredthattheengagement
personnelfailedtoconfirm
severaloftheclientsmaterial
accountsreceivablebalances.
Theauditorshouldfirst
a.
b.
Perform alternative
procedurestoprovidea
satisfactory basis for
theunqualifiedopinion.
Assess the importance
of the omitted
procedures to the
auditors ability to
support the previously
expressedopinion.
c.
d.
a.
b.
c.
d.
c.
d.
Determine whether
inadequate provisions
forthesafeguardingof
assets have been
corrected.
Consider whether the
results of audit
procedures affect the
assessmentofthe risk
of material mis
statementduetofraud.
in
managements
financialrecords.
c. The verification that a
companys financial
statements are fairly
presented.
d. Past
protection
provided by existing
internalcontrol.
169. A typical objective of an
operational audit is to deter
minewhetheranentitys
a. Internal control is
adequately
operating as de
signed.
b. Operational
informationisin
accordancewith
generallyaccepted
governmental
auditingstandards.
c. Financial statements
present fairly the
resultsofoperations.
d. Specific operating units are
functioning efficiently and
effectively.
MODULE4RESPONDINGTORISKASSESSMENT
128
SIMULATIONS
TaskBasedSimulation1
AuditInvestmentsand
AccountsReceivable
Authoritative
Literature
Help
Items1through7representauditobjectivesfortheinvestmentsandaccountsreceivable.Totherightofeachsetof
auditobjectivesisalistingofpossibleauditproceduresforthataccount.Foreachauditobjective,selecttheauditprocedure
thatwouldprimarilyrespondtotheobjective.Selectonlyoneprocedureforeachauditobjective.Aproceduremaybeselected
onlyonce,ornotatall.
Auditproceduresforinvestments
A. Traceopeningbalancesinthesubsidiaryledgertoprioryearsauditworkingpapers.
B. Determinethatemployeeswhoareauthorizedtosellinvestmentsdonothaveaccesstocash.
C. Examinesupportingdocumentsforasampleofinvestmenttransactionstoverifythatprenumbereddocuments
areused.
D. Determinethatanyimpairmentsinthepriceofinvestmentshavebeenproperlyrecorded.
E. Verifythattransfersfromthecurrenttothenoncurrentinvestmentportfoliohavebeenproperlyrecorded.
F. Obtainpositiveconfirmationsasofthebalancesheetdateofinvestmentsheldbyindependentcustodians.
G. TraceinvestmenttransactionstominutesoftheBoardofDirectorsmeetingstodeterminethattransactions
wereproperlyauthorized.
A
u
1.
2.
3.
T
A
u
A.
Analyzetherelationshipofaccountsreceivableandsalesandcompareitwithrelationshipsforprecedingperiods.
B. Performsalescutoffteststoobtainassurancethatsalestransactionsandcorrespondingentriesforinventoriesand
costofgoodssoldarerecordedinthesameandproperperiod.
C. Reviewtheagedtrialbalanceforsignificantpastdueaccounts.
D. Obtainanunderstandingofthebusinesspurposeoftransactionsthatresultedinaccountsreceivablebalances.
E. Reviewloanagreementsforindicationsofwhetheraccountsreceivablehavebeenfactoredorpledged.
F. Reviewtheaccountsreceivabletrialbalanceforamountsduefromofficersandemployees.
G. Analyzeunusualrelationshipsbetweenmonthlyaccountsreceivablebalancesandmonthlyaccountspayable
balances.
4.
A
u
A
5.
6.
7.
TaskBasedSimulation2
Research
Authoritative
Literature
Help
ConfirmationofAccountsReceivable
BillSmith,thepresidentofAlexInc.,anonpublicauditclient,hassuggestedtoyouthathispreviousauditordidnot
confirmaccountsreceivableandheseesnoreasonwhyyoushoulddoso.
MODULE4RESPONDINGTORISKASSESSMENT
Selections
A. AU
129
B. PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
(A)(B)(C)(D)(E)(F)(G)(H)
1. WhichtitleoftheProfessionalStandardsaddressesthisissueandwillbe
helpfulinrespondingtohim?
2. Entertheexactsectionandparagraphwithhelpfulinformation.
TaskBasedSimulation3
IllegalActsandRelated
PartyTransactions
Authoritative
Literature
Help
In applying audit procedures and evaluating the results of those procedures, auditors may encounter specific
informationthatmayraise a questionconcerningtheexistenceofillegalacts andrelatedpartytransactions.Indicate
whethereachofthefollowingismorelikelyrelatedtoanillegalact(IA)orarelatedpartytransaction(RP).
3.
S
t
A
T
h
U
4.
5.
L
a
1.
2.
TaskBasedSimulation4
AccountsReceivable
Confirmations
Authoritative
Literature
Help
Anauditormayuseconfirmationsofaccountsreceivable.Replyastowhetherthefollowingstatementsarecorrectorin
correctwithrespecttotheconfirmationprocesswhenappliedtoaccountsreceivable.
4.
S
t
T
h
A
S
e
C
5.
6.
A
b
A
u
A
u
1.
2.
3.
7.
8.
130
S
t
9.
T
h
10. A
c
MODULE4RESPONDINGTORISKASSESSMENT
TaskBasedSimulation5
Auditing
Inventory
Authoritative
Literature
Help
Auditorsoftenobservethecountingoftheirclientsinventories.Replyastowhetherthe
followingstatementsarecorrect
orincorrectwithrespecttotheinventoryobservation.
Statement
1. Withstronginternalcontrol,theinventorycountmaybeattheendoftheyearoratother
times.
2. Whenaclienthasmanyinventorylocations,auditorsordinarilyneednotbepresentat
eachlocation.
3. Allauditortestcountsmustbedocumentedintheworkingpapers.
4. Auditorsobservationofthecountingoftheirclientsinventoriesaddressestheexistence
ofinventory,andnotthecompletenessofthecount.
5. Whentheclientmanufacturesaproduct,directlaborandoverheadordinarilybecomea
partofinventoryitemcosts.
6. Inventoryisordinarilyvaluedatthelowerofstandardcostormarket.
7. Inventoryitemspresentasconsignedinshouldnotbeincludedintheclientsinventory
value.
8. Auditorrecordingoftestcountsordinarilyreplacestheneedforclienttaggingofin
ventory.
9. Ordinarily,anauditorneednotcountallitemsintheinventory.
10. Atthecompletionofthecount,anauditorwillordinarilyprovidetheclientwithcopiesof
hisorherinventorytestcountstohelpassureinventoryaccuracy.
TaskBasedSimulation6
Research
Authoritative
Literature
Help
AuditingDerivatives
Thepartnerinchargeoftheaudityouarecurrentlyworkingonisconcernedabout
overallriskinvolvedwithcertainfinancialderivativetransactionstheclientisinvolved
with.Morespecifically,shehasaskedyoutofindguidanceintheProfessionalStandards
ondeterminingthatalloftheclientsderivativesareproperlyreported.
Selections
A. AU
B. PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
(A)
(B)
(C)
(D)
(E)
(F)
(G)
Correct
Incorrect
(H)
1.
WhichtitleoftheProfessionalStandardsaddressesthisissueandwillbe
helpfulinrespondingtoher?
2.
Entertheexactsectionandparagraphwithhelpfulinformation.
MODULE4RESPONDINGTORISKASSESSMENT
131
TaskBasedSimulation7
Bank
Reconciliation
Authoritative
Literature
Help
Items1through6representtheitemsthatanauditorordinarilywouldfindonaclient
preparedbankreconciliation.TheaccompanyingListofAuditingProceduresrepresents
substantiveauditingprocedures.Foreachitem,selectoneormoreprocedures,asindicated,
thattheauditormostlikelywouldperformtogatherevidenceinsupportofthatitem.The
proceduresontheListmaybeselectedonce,morethanonce,ornotatall.
Assume
Theclientpreparedthebankreconciliationon10/2/05.
Thebankreconciliationismathematicallyaccurate.
Theauditorreceivedacutoffbankstatementdated10/7/05directlyfromthebankon
10/11/05.
The9/30/05depositintransit,outstandingchecks#1281,#1285,#1289,and#1292,
andthecorrectionoftheerrorregardingcheck#1282appearedonthecutoffbank
statement.
Theauditorassessedcontrolriskconcerningthefinancialstatementassertionsrelated
tocashatthemaximum.
ListofAuditingProcedures
F. Inspectbankdebitmemo.
G. Ascertainreasonforunusualdelay.
H. Inspect supporting documents for reconciling
itemnotappearingoncutoffstatement.
I. Traceitemsonthebankreconciliationtocutoff
statement.
J. Trace items on the cutoff statement to bank
reconciliation.
Tracetocashdisbursements
journal.
C. Compareto9/30/01general
ledger.
D. Confirmdirectlywithbank.
E. Inspectbankcreditmemo.
GeneralCompany
BANKRECONCILIATION
1STNATIONALBANKOFUSBANKACCOUNT
September30,2005
1.
Select2Procedures
2.
Select5ProceduresDepositsintransit
9/29/05
9/30/05
Balanceperbank
28,375
3. Select5Procedures
4. Select1Procedure
5. Select2Procedures
6. Select1Procedure
Outstandingchecks
#988
8/31/05
#1281
9/26/05
#1285
9/27/05
#1289
9/29/05
#1292
9/30/05
Customernotecollectedbybank
Error:Check#1282,writtenon9/26/05
for$270waserroneouslychargedbybank
as$720;bankwasnotifiedon10/2/05
Balanceperbooks
TaskBasedSimulation8
Audit
Procedures
Authoritative
$4,500
1,525
2,200
675
850
2,500
7,225
6,025
34,400
(13,450)
20,950
(3,000)
450
$18,400
Literature
Help
Items1through12representpossibleerrorsandfraudthatyoususpectmaybepresentat
GeneralCompany.TheaccompanyingListofAuditingProceduresrepresentsproceduresthat
theauditorwouldconsiderperformingtogatherevidenceconcerningpossibleerrorsand
fraud.Foreachitem,selectoneortwoprocedures,asindicated,thattheauditormostlikely
wouldperformtogatherevidenceinsupportofthatitem.Theproceduresonthelistmaybe
selectedonce,morethanonce,ornotatall.
MODULE4RESPONDINGTORISKASSESSMENT
132
A.
Comparethedetailsofthecash
receiptsjournalentrieswiththe
detailsofthecorrespondingdaily
depositslips.
B.
Scanthedebitstothefixedasset
accountsandvouchselectedamounts
tovendorsinvoicesand
managementsauthorization.
C.
D.
E.
F.
N.
J.
Sendrequeststoconfirmtheentitys
accounts receivable on a surprise
basisataninterimdate.
K.
ListofAuditingProcedures
L. Examinetheentitysshipping
documentstoverifythatthe
merchandisethatproducedthe
receivablewasactuallysenttothe
customer.
M. Inspecttheentityscorrespondence
filesforindicationsofcustomer
disputesforevidencethatcertain
shipmentswereonconsignment.
Performeditchecksofdataonthepayroll
transactiontapes.
O. Inspect payroll check
endorsements for similar
handwriting.
Observe payroll check distribution on a
surprisebasis.
Q. Vouchdatainthepayrollregisterto
documentedauthorizedpayratesin
thehumanresourcesdepartments
files.
R. Reconcilethepayrollchecking
accountanddetermineiftherewere
unusualtimelagsbetweenthe
issuanceandpaymentofpayroll
checks.
S. Inspectthefileofprenumbered
vouchersforconsecutivenumbering
andproperapprovalbyan
appropriateemployee.
T. Determine that the details of
selected
prenumbered
vouchers match the related
vendorsinvoices.
U. Examinethesupportingpurchase
orders and receiving reports for
selectedpaidvouchers.
Possiblemisstatementsduetoerrorsandfraud
1.
2.
Anauditorsuspectsthatthecontrollerwroteseveralchecksandrecordedthecash
disbursementsjustbeforeyearendbutdidnotmailthechecksuntilafterthefirst
weekofthesubsequentyear.(Selectonly1procedure)
3.
Theentityborrowedfundsfromafinancialinstitution.Althoughthetransaction
wasproperlyrecorded,theauditorsuspectsthattheloancreatedalienonthe
entitysrealestatethatisnotdisclosedinitsfinancialstatements.(Selectonly
1procedure)
4.
Theauditordiscoveredanunusuallylargereceivablefromoneoftheentitysnew
customers.Theauditorsuspectsthatthereceivablemaybefictitiousbecausethe
auditorhasneverheardofthecustomerandbecausetheauditorsinitialattemptto
confirm the receivable has been ignored by the customer. (Select only 2
procedures)
5.
Theauditorsuspectsthatfictitiousemployeeshavebeenplacedonthepayrollby
the entitys payroll supervisor, who has access to payroll records and to the
paychecks.(Selectonly1procedure)
6.
only1procedure)
7.
Theentityscashreceiptsofthefirstfewdaysofthesubsequentyearwereproperly
depositedinitsgeneraloperatingaccountaftertheyearend.However,theauditor
suspectsthattheentityrecordedthecashreceiptsinitsbooksduringthelastweekofthe
yearunderaudit.(Selectonly1procedure)
8.
Theauditorsuspectsthatvoucherswerepreparedandprocessedbyanaccounting
departmentemployeeformerchandisethatwasneitherorderednorreceivedby
theentity.(Selectonly1procedure)
9.
Thedetailsofinvoicesforequipmentrepairswerenotclearlyidentifiedorexplainedto
the accounting department employees. The auditor suspects that the bookkeeper
incorrectlyrecordedtherepairsasfixedassets.(Selectonly1procedure)
10. Theauditorsuspectsthatalappingschemeexistsbecauseanaccounting
departmentemployeewhohasaccesstocashreceiptsalsomaintainstheaccounts
receivableledgerandrefusestotakeanyvacationorsickdays.(Selectonly2
procedures)
11. Theauditorsuspectsthattheentityisinappropriatelyincreasingthecashreported
onitsbalancesheetbydrawingacheckononeaccountandnotrecordingitasan
outstandingcheckonthataccountandsimultaneouslyrecordingitasadepositina
secondaccount.(Selectonly1procedure)
12. Theauditorsuspectsthattheentityscontrollerhasoverstatedsalesandaccounts
receivablebyrecordingfictitioussalestoregularcustomersintheentitysbooks.
(Selectonly2procedures)
MODULE4RESPONDINGTORISKASSESSMENT
133
TaskBasedSimulation9
SubstantiveProceduresforProperty,Plantand
Equipment
Authoritative
Literature
Help
DietWebInc.(hereafterDietWeb)wasincorporatedandbeganbusinessinMarchof
20X1,sevenyearsago.Youareworkingonthe20X8audityourCPAfirmsfifthauditof
DietWeb.Foreachauditobjective,selectasubstantiveprocedurethatwouldhelptoachieve
thatobjective.Eachoftheproceduresmaybeusedonce,morethanonce,ornotatall.
Substantiveprocedure
Traceopeningbalancesinthesummaryschedulestotheprioryearsauditworking
A.
papers.
B. Reviewtheprovisionfordeprecationexpenseanddeterminethatdepreciablelives
andmethodsusedinthecurrentyearareconsistentwiththoseusedintheprior
year.
C. Determinethatresponsibilityformaintainingthepropertyandequipmentrecordsis
segregatedfromtheresponsibilityforcustodyofpropertyandequipment.
D.
Examinedeedsandtitleinsurancecertificates.
E.
Performcutofftesttoverifythatpropertyandequipmentadditionsarerecordedin
theproperperiod.
F.
Determinethatpropertyandequipmentisadequatelyinsured.
G.
Physicallyexamineallrecordedmajorpropertyandequipmentadditions.
H.
Analyzerepairsandmaintenanceexpense.
AuditObjective
(A)(B)(C)
(D)(E)(F)
(G)(H)
1.
DietWebhaslegalrightstopropertyandequipmentacquiredduringtheyear.
2.
DietWebrecordedpropertyandequipmentacquiredduringtheyearthatdidnot
actuallyexistatthebalancesheetdate.
3.
6.
DietWebspropertyandequipmentwasproperlyvaluedatthebalancesheetdate.
4.
5.
DietWebrecordedallpropertyretirementsthatoccurredduringtheyear.
DietWebcapitalizedallacquisitionsthatoccurredduringtheperiod.
TaskBasedSimulation10
RiskAnalysis
Authoritative
Literature
Help
YouareworkingwithWilliamBond,CPA,andyouareconsideringtheriskofmaterial
misstatementinplanningtheauditofToxicWasteDisposal(TWD)Companysfinancial
statementsfortheyearendedDecember31,20X0.
Assumethatyouhaveidentifiedthefollowingrisksattheaccountlevelrelatingto
TWDspropertyandequipment.Identifythemostcloselyrelatedfinancialstatement
assertionandtheauditprocedurethatmightbeplannedtomostlikelyaddresstherisk.
Financialstatementassertionsandauditproceduresmaybeusedonce,morethanonce,ornot
usedatall.
Relatedfinancialstatementassertion
A.Existenceoroccurrence
B.Completeness
C.Rightsandobligations
D.Valuationorallocation
E.Presentationanddisclosure
Auditprocedures
F. Traceopeningbalancesinthesummaryschedulestotheprioryears
auditworkingpapers.
G. Reviewtheprovisionfordepreciationexpenseanddeterminethatde
preciablelivesandmethodsusedinthecurrentyearareconsistentwith
thoseusedintheprioryear.
H.Determinethattheresponsibilityformaintainingthepropertyand
equipmentrecordsissegregatedfromtheresponsibilityforcustodyof
propertyandequipment.
I. Examinedeedsandtitleinsurancecertificates.
J. Performcutoffsteststoverifythatpropertyandequipmentadditions
arerecordedintheproperperiod.
K. Determinethatpropertyandequipmentareadequatelyinsured.
L. Physicallyexamineallmajorpropertyandequipmentadditions.
MODULE4RESPONDINGTORISKASSESSMENT
134
Riskidentified
1.
2.
Recordednetpropertyand
equipment are for proper
amounts.
Relatedfinancialstatementassertion
(A)(B)(C)(D)(E)
Auditprocedures
(F)(G)(H)(I)(J)(K)(L)
TaskBasedSimulation11
AuditObjectives
andProcedures
Authoritative
Literature
Help
Foreachauditobjectivelistedbelowselectthemostappropriateauditprocedurefor
rawmaterialsinventory(Items13)andforAccountsReceivable(Items46).Audit
proceduresmaybeusedonce,morethanonce,ornotatall.
Listofauditproceduresforrawmaterialsinventory
A.
B.
Comparestandardcostsofinventorieswithstandardizedmarketvalues.
Determinethatalldirectlaborandoverheadhasbeenexpensedandnotincludedin
inventoryvaluation.
C.
Examinevendorsinvoices.
D.
Performanalyticalprocedurescomparinginventorytovariousindustryaverages.
E.
Reviewdraftsoffinancialstatementnotedisclosures.
F.
Selectasampleofitemsduringthephysicalcountanddeterminethattheclienthas
includeditemsoninventorycountsheets.
G.
Selectasampleofrecordeditemsoncountsheetsanddeterminethattheitemsareon
hand.
1.
2.
3.
D
L
i
A. Analyzerelationshipsbetweenaccountsreceivablebalancesandchangesinthecurrent
portionoflongtermdebt.
B. Compare accounts receivable on the accounts receivable lead schedule with those on
supportingauditschedules.
C. Comparetotal20X8annualsaleswiththoseof20X7.
D. ExamineDecember20X8salesjournalanddeterminethatsalesareproperlyrecordedin
December.
E. ExamineJanuary20X9salesjournalanddeterminethatsalesareproperlyrecordedin
January.
F. Inquireofcreditmanageraboutthecollectabilityofvariousreceivables.
G. Review disclosure checklist for recommended and required accounts receivable
disclosures.
4.
5.
D
e
6.
TaskBasedSimulation12
InventoryAuditObjectives
andProcedures
Authoritative
Literature
Help
Theauditordeterminesthateachofthefollowingobjectiveswillbepartoftheauditof
EnrightCorporation.Foreachauditobjective,selectasubstantiveprocedurethatwouldhelp
toachievetheauditobjectives.Eachoftheproceduresmaybeusedonce,morethanonce,or
notatall.
MODULE4RESPONDINGTORISKASSESSMENT
Substantiveprocedure
A. Review minutes of board of directors meetings and contracts, and make inquiries of
management.
B. Testinventorytransactionsbetweenapreliminaryphysicalinventorydateandthebalance
sheetdate.
135
C. Obtainconfirmationofinventoriespledgedunderloanagreement.
D. Review perpetual inventory records, production records, and purchasing records for
indicationofcurrentactivity.
E. Reconcile physical counts to perpetual records and general ledger balances and
investigatesignificantfluctuation.
F. Examinesalesafteryearendandopenpurchaseordercommitments.
G. Examinepaidvendorsinvoices,consignmentagreements,andcontracts.
H. Analyticallyreviewandcompare therelationshipofinventory balance torecent
purchasing,production,andsalesactivity.
1.
2.
3.
4.
D
e
D
5.
TaskBasedSimulation13
Spreadsheet
Completion
Authoritative
Literature
Help
Analyticalproceduresareevaluationsoffinancialinformationmadebyastudyof
plausiblerelationshipsamongfinancialandnonfinancialdata.Understandingandevaluating
suchrelationshipsareessentialtotheauditprocess.
ThefollowingspreadsheetwiththefinancialstatementswerepreparedbyHoliday
ManufacturingCo.fortheyearendedDecember31,20X1.Alsopresentedarevarious
financialstatementratiosforHolidayascalculatedfromtheprioryearsfinancialstatements.
Salesrepresentnetcreditsales.Thetotalassetsandthereceivablesandinventorybalancesat
December31,20X1,werethesameasatDecember31,20X0.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
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24
25
26
27
28
29
136
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
A
Holiday Manufacturing Co.
Balance Sheet
December 31, 20X1
Cash
Receivables
Inventory
Total current assets
$240,000
400,000
600,000
$1,240,000
Accounts Payable
Notes payable
Other current liabilities
Total current liabilities
760,000
Total assets
$160,000
100,000
140,000
400,000
Long-term debt
Common stock
Retained earnings
Total liabilities and capital
$2,000,000
350,000
750,000
500,000
$2,000,000
Income Statement
Year ended December 31, 20X1
Sales
Cost of goods sold
Materials
Labor
Overhead
Gross margin
Selling expenses
General and admin. exp.
Operating income
Less: interest expense
$3,000,000
800,000
700,000
300,000
1,800,000
1,200,000
240,000
300,000
MODULE4
A
Income before taxes
Less: federal income taxes
Net income
Ratios
Current ratio
Quick ratio
Accounts receivable turnover
Inventory turnover
Total asset turnover
Gross margin %
Net operating margin %
Times interest earned
540,000
660,000
40,000
RESPONDINGTORISKASSESSMENT
C
F
620,000
220,000
$400,000
12/31/X1
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
12/31/X0
2.5
1.3
5.5
2.5
1.2
35%
25%
10.3
(9)
50%
Insertspreadsheetformulasintotheworksheettoallowthedirectioncalculationof
eachratio(1through9).Usecelllocationratherthanamounts.
MODULE4RESPONDINGTORISKASSESSMENT
137
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
b
b
c
c
d
d
a
a
d
d
d
d
c
a
b
c
a
d
b
c
c
c
a
b
c
b
c
b
c
c
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31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
43.
44.
45.
46.
47.
48.
49.
50.
51.
52.
53.
54.
55.
56.
57.
58.
59.
60.
c
d
c
b
a
a
a
c
c
d
b
a
d
c
b
b
c
b
d
b
b
b
c
d
b
c
b
c
b
a
__
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__
61.
62.
63.
64.
65.
66.
67.
68.
69.
70.
71.
72.
73.
74.
75.
76.
77.
78.
79.
80.
81.
82.
83.
84.
85.
86.
87.
88.
89.
90.
a
c
b
c
a
d
d
a
b
d
a
d
c
a
a
d
c
b
a
b
a
b
d
a
c
c
c
c
a
d
__
__
__
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91.
92.
93.
94.
95.
96.
97.
98.
99.
100.
101.
102.
103.
104.
105.
106.
107.
108.
109.
110.
111.
112.
113.
114.
115.
116.
117.
118.
119.
120.
b
a
d
c
a
b
a
c
c
a
d
c
c
b
a
c
b
a
d
a
d
d
d
b
c
c
a
c
b
d
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121.
122.
123.
124.
125.
126.
127.
128.
129.
130.
131.
132.
133.
134.
135.
136.
137.
138.
139.
140.
141.
142.
143.
144.
145.
146.
147.
148.
149.
150.
c
a
c
b
d
a
a
a
d
c
c
a
a
d
b
c
c
d
b
c
b
b
a
a
b
a
b
c
c
d
MULTIPLECHOICEANSWEREXPLANATIONS
transactions.Answer(a),(c),
and(d)areallincorrectbecause
accuracy,cutoffandoccurrence
areclassoftransaction
assertions.
A.1.SufficientAppropriateAudit
Evidence
1.(b)Therequirementistoidentifythe
statementthatbestdescribesthemeaningof
generallyacceptedauditingstandards.
Answer(b)iscorrectbecausegenerally
acceptedauditingstandardsdealwith
measuresofthequalityoftheperformance
ofauditprocedures.Answer(a)isincorrect
becauseproceduresrelatetoactstobe
performed,notdirectlytothestandards.
Answer(c)isincorrectbecausegenerally
acceptedauditingstandardshavebeen
issuedbypredecessorgroups,aswellasby
theAuditingStandardsBoard.Answer(d)
isincorrectbecausetheremayormaynot
beuniversalcompliancewiththe
standards.
2.
(b)Therequirementisto
identifythereplythatisnotan
assertionforclassesof
transactions.Theassertionsfor
classesoftransactionsare
occurrence,completeness,
accuracy,cutoffand
classification.Answer(b)is
correctsinceconsistencyisnot
anassertionforclassesof
3.
(c)Therequirementistoidentifythetype
ofevidencethatisgenerallymostreliable.
Answer(c)iscorrectbecauseaudit
evidenceobtainedfromknowledgeable
independentsourcesoutsidetheclient
companyismorereliablethanaudit
evidenceobtainedfromnonindependent
sources(e.g.,companysourceswhomaybe
biased).Answer(a)isincorrectbecause
auditevidenceobtainedfromdirectsources
ismorereliable.Answer(b)is
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151.
152.
153.
154.
155.
156.
157.
158.
159.
160.
161.
162.
163.
164.
165.
166.
167.
168.
169.
d
c
d
c
d
d
c
d
a
b
c
b
c
c
c
b
d
a
d
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1st:__/169=__%
2nd:__/169=__%
incorrectbecauseitisnotclearasto
whethercopiesorfacsimilecopiesare
morereliable.Answer(d)isincorrect
becauseitisunclearwhetheraudit
evidenceprovidedbyoriginaldocuments
ismorereliablethanthatprovidedthrough
asystemofeffectivecontrolsindeed,
theymaybeoneandthesame.
4.
(c)Therequirementistoidentify
themostpersuasivetypeof
evidence.Answer(c)iscorrect
becauseabankstatement
representsevidenceprepared
outsideoftheentityandis
consideredanauditevidence
sourcewhichprovidestheauditor
withahighlevelofassurance.
Answers(a),(b),and(d)are
incorrectbecauseprenumbered
clientpurchaseorderforms,
clientworksheetsanda
representationletterallrepresent
internallygenerateddocuments,
generallyconsideredless
persuasivethanexternally
generateddocuments.SeeSAS
106forinformationonthe
persuasivenessofauditevidence.
5.
(d)Therequirementistoidentifyacorrect
presumptionaboutthereliabilityofaudit
evidence.Answer(d)iscorrectbecause
SAS106indicatesthateffectiveinternal
controlprovidesmoreassuranceaboutthe
reliabilityofauditevidencethanineffective
control.Answer(a)isincorrectbecause
informationobtaineddirectlyisconsidered
morereliablethanthatobtainedindirectly.
Answer(b)isincorrectbecauseaudit
evidenceisnormallypersuasiveratherthan
convincing.Answer(c)isincorrectbecause
reliabilityofauditevidencerelatestothe
appropriatenessofauditevidence.
MODULE4RESPONDINGTORISKASSESSMENT
138
6.
7.
8.
(d)Therequirementisto
determinethecorrectstatement
withrespecttothe
appropriatenessofauditevi
dence.Tobeappropriate,
evidencemustbebothreliable
andrelevant.Answer(a)is
incorrectbecausewhileexter
nallygeneratedevidenceis
generallyconsideredtoprovide
greaterassuranceofreliability,
thereareimportantexceptions,
(e.g.,theconfirmationis
erroneouslyreturnedwithno
exceptionwhenoneactually
exists).Answer(b)isincorrect
becausewhileevidenceso
gatheredistypicallyconsideredto
providegreaterassurance
concerningreliability,nosimilar
generalizationcanbemadeabout
itsrelevance.Answer(c)is
incorrectbecauseoral
representationsfromman
agement,whencorroboratedby
otherformsofevidence,are
consideredvalidevidence.
(a)Therequirementistoidentify
theleastpersuasivetypeof
evidence.Answer(a)iscorrect
becauseevidencesecuredsolely
fromwithintheentity,here
prenumberedpurchaseorder
forms,isconsideredless
persuasivethanevidence
obtainedfromindependent
sources.Answer(b)isincorrect
becauseabankstatement(even
thoughreceivedfromtheclient)
isexternallycreatedand
thereforemorepersuasivethan
auditevidencesecuredsolely
fromwithintheentity.Answer
(c)isincorrectbecauseevidence
obtaineddirectlybytheauditor
throughobservationiscon
sideredrelativelypersuasive.
Answer(d)isincorrectbecause
correspondencefromtheclients
attorneyaboutlitigationis
obtaineddirectlyfrom
independentsourcesandis
thereforemorepersuasivethan
auditevidencesecuredfrom
withintheentity.
(a)Therequirementistoidentifyanareaof
concerntoauditorswhenevaluatingthe
reasonablenessofanentitysaccounting
estimates.Answer(a)iscorrectbecause
AU342statesthatinevaluatingthe
reasonablenessofestimatesauditors
normallyconcentrateonassumptionsthat
aresubjectiveandsusceptibletobias.
Answer(b)isincorrectbecauseallthings
beingequal,anauditorwouldexpectas
sumptionsthatareconsistentwithprior
periods.Answer(c)isincorrectbecause
assumptionsthatareinsensitiveto
variationsinunderlyingdatahavelittle
predictiveability.Answer(d)isincorrect
because,often,onewouldexpect
assumptionssimilartoindustryguidelines.
A.2.TypesofEvidence
9.
(d)Therequirementistoidentify
thereplythatisnotabasic
procedureusedinanaudit.
Answer(d)iscorrectbecausethe
termtestofdirectevidenceis
notusedintheprofessional
standards.Answer(a)isincorrect
becauseriskassessment
proceduresareusedwhile
obtaininganunderstandingofthe
client.Answer(b)isincorrect
becausesubstantiveprocedures
testaccountbalances.Answer(c)
isincorrectbecausetestsof
controlstesttheoperatingeffec
tivenessofcontrols.
10. (d)Therequirementistoidentify
theprocedureanauditorwould
performfirstinevaluating
managementsaccountingestimates
forreasonableness.Answer(d)is
correctbecauseinevaluating
reasonableness,theauditorshould
firstobtainanunderstandingofhow
managementdevelopedthe
estimate.Answers(a),(b),and(c)
areallincorrectbecause
developingindependent
expectations,considering
appropriatenessofkeyfactorsor
assumptions,andtesting
calculationsoccurafterobtaining
theunderstanding.SeeAU342for
informationonauditingaccounting
estimates.
11. (d)Therequirementistoidentifyafactor
thatanauditorwouldconcentrateupon
whenevaluatingthereasonablenessofan
accountingestimate.Answer(d)iscorrect
becauseAU342statesthattheauditor
normallyconcentratesonkeyfactorsand
assumptionsthataredeviationsfrom
historicalpatterns,aswellasthosethatare
significanttotheaccountingestimate,
sensitivetovariations,andsubjectiveand
susceptibletomisstatementandbias.
Answer(a)isincorrectbecausedeviations
fromhistoricalpatterns,notconsistent
patterns,areconcentratedupon.Answer(b)
isincorrectbecausefactorsand
assumptionsthataresimilartoindustry
guidelinesareoftenreasonable.Answer(c)
isincorrectbecausesubjectivefactorsand
assumptionsthataresusceptibletobiasare
concentratedupon,notobjectiveonesthat
arenotsusceptibletobias.SeeAU342for
informationonthemannerinwhich
auditorsconsideraccountingestimates.
12. (d)Therequirementisto
identifyoneofanauditors
objectiveswhenevaluatingan
entitysaccountingestimates.
Answer(d)iscorrectbecause
whenevaluatingaccounting
estimatesanauditorsobjectives
aretoobtainsufficient
appropriateauditevidencethat
(1)allmaterialaccounting
estimateshavebeendeveloped,
(2)thoseaccountingestimates
arereasonable,and(3)those
accountingestimatesarein
conformitywithGAAP.
13. (c)Therequirementisto
determinethepropertestforthe
existenceassertionofanasset.
Answer(c)iscorrectbecause
testingfromaccountingrecords
tothesupportingevidence
discloseswhetherrecorded
transactionsoccurredand
whethertheassetexists.Answer
(a)isincorrectbecausetesting
forthecompletenessassertion
addresseswhetherthereare
unrecordeditems.Also,the
aggregatednatureofthefinancial
statementsmakestheuseof
potentiallyunrecordeditems
unlikelyasamethodof
identifyingunrecordeditems.
Answer(b)isincorrectbecause
testingpotentiallyunrecorded
itemstothefinancialstatements
addressesthecompleteness
assertion.Answer(d)isincorrect
becausetestingfromthe
supportingevidencetotheac
countingrecordsaddressesthe
completenessassertion.Seethe
outlineofSAS106for
informationonthefinancial
statementassertions.
14. (a)Therequirementisto
determinewhichbalance
remaininginasuspense
accountwouldbeofmostcon
cerntoanauditor.Answer(a)is
correctbecausesuspensedebits
thatmanagementbelieveswill
benefitfutureoperationsmustbe
auditedcarefullytodetermine
whethertheyhavevalueand
shouldbeclassifiedasanasset.
Answer(b)isincorrectbecause
whenanauditorhasalready
determinedthatasuspensedebit
hasvalueitbecomesarelatively
straightforwardissueofthe
itemsproperclassification.
Answer(c)isincorrectbecause
theconservativeapproachtaken
inauditsislikelytocausethe
auditortohavesomewhatmore
concernaboutsuspensepurported
tobeassets[i.e.,answer(a)],
thanforthoseclassifiedas
currentliabilities.Answer(d)is
incorrectbecausewhenthe
auditordeterminesthatthe
suspensecreditsrepresent
customerdeposits,establishinga
properaccountingwillordinarily
berelativelysimple.
B.1.a.
AnalyticalProcedures
15.(b)Therequirementistoidentifythe
procedurethatwouldnotbeconsideredan
analyticalprocedure.Analyti
MODULE4RESPONDINGTORISKASSESSMENT
calproceduresconsistofevaluationsof
financialinformationmadebyastudyof
plausiblerelationshipsamongboth
financialandnonfinancialdata.Answer(b)
iscorrectbecauseprojectinganerrorrate
fromastatisticalsampletoanactual
populationisnotacomparisonofa
plausiblerelationship.Answers(a),(c),
and(d)areallincorrectbecausetheyall
includeastudyofplausiblerelationships.
16. (c)Therequirementistoidentifythetype
ofanalyticalprocedureanauditorwould
mostlikelyuseindevelopingrelationships
amongbalancesheetaccountswhen
reviewingthefinancialstatementsofa
nonpublicentity.Answer(c)iscorrect
becausebalancesheetaccountsmaybe
analyzedthroughanumberofratios(e.g.,
currentratio).Answer(a)isincorrect
becausetrendanalysisisoftenmore
appropriateforincomestatementanalysis.
Answer(b)isincorrectbecauseregression
analysis,whileusedinpractice,isnotused
asfrequentlyasisratioanalysis.Answer
(d)isincorrectbecauseriskanalysisinand
ofitselfisnotatypeofanalytical
procedure.SeeAR100forinformationon
reviewsofnonissuer(nonpublic)entities.
17. (a)Therequirementistoidentify
howanauditormayachieveaudit
objectivesrelatedtoparticular
assertions.Answer(a)iscorrect
becauseanauditormayperform
analyticalprocedurestoachieve
anauditobjectiverelatedtoa
particularassertion.Answer(b)is
incorrectbecauseasystemof
qualitycontrolprovidestheCPA
firmwithreasonableassurance
ofconformingwithprofessional
standards.Answer(c)isincorrect
becausewhileworkingpapers
providesupportfortheaudit
reportandaidintheconductand
supervisionoftheaudit,theydo
notinandofthemselvesachieve
auditobjectives(seeSAS103for
informationonauditworking
papers).Answer(d)isincorrect
becauseincreasingthelevelof
detectionriskdoesnotinandof
itselfachieveauditobjectives.
18. (d)Therequirementistoidentify
theproceduremostlikelyto
detectafraudinvolving
misstatementofincome
statementsduetotherecording
ofjournalentrieswithunusual
combinationsofdebitsand
creditstoexpenseandrevenue
accounts.Answer(d)iscorrect
becauseanobjectiveof
139
analyticalproceduresis
identificationofunusual
transactionsandevents,and
amounts,ratiosandtrendsthat
mightindicatemisstatements.
Answer(a)isincorrectbecause
thelimitednumberofjournal
entriestracedtothegeneral
ledgerinasampleisunlikelyto
includetheerroneousjournal
entries.Answer(b)isincorrect
becausewhileanevaluationof
theeffectivenessofinternal
controlmighthelpdetectsuch
misstatements,itissomewhat
doubtfulduetothefactthatitis
likelythatfewjournalentriesare
involved.Answer(c)isincorrect
becausethereisnoindication
thatthefraudinvolves
differencesbetweencontrolling
accountsandsubsidiaryrecords.
19. (b)Therequirementisto
identifytheaccountthatwould
yieldthehighestlevelof
evidencethroughtheper
formanceofanalytical
procedures.Ashigherlevelsof
assurancearedesiredfrom
analyticalprocedures,morepre
dictablerelationshipsare
requiredtodeveloptheauditors
expectation.Relationships
involvingincomestatementac
countstendtobemore
predictablethanrelationshipsin
volvingonlybalancesheet
accounts,andrelationshipsin
volvingtransactionsnotsubject
tomanagementdiscretionare
generallymorepredictable.
Answer(b)iscorrectbecause
interestexpenserelatestothe
incomestatement,and
areoftenlesspredictable.
becauseinterestexpenseissubjectto
onlylimitedmanagementdiscretion,
giventheexistenceoftherelateddebt.
Answers(a)and(c)areincorrectbecause
accountsreceivableandaccounts
payablearebalancesheetaccounts.An
swer(d)isincorrectbecausetraveland
entertainmentexpenseisnormally
subjecttomanagementdiscretion.See
AU329formoreinformationontheuse
ofanalyticalprocedures.
20. (c)Therequirementistodeterminewhatis
includedwhenanalyticalproceduresare
usedintheoverallreviewstageofanaudit.
Answer(c)iscorrectbecausetheoverall
reviewstageincludesreadingthefinancial
statementsandnotesandconsideringthe
adequacyofevidencegatheredinresponse
tounusualorunexpectedbalances.Answer
(a)isincorrectbecauseanalytical
proceduresarenotparticularlyaimedat
gatheringevidenceonaccountbalances
thathavenotchanged.Answer(b)is
incorrectbecauseanalyticalproceduresdo
notdirectlytestcontrolprocedures.Answer
(d)isincorrectbecausetestsoftransac
tionstocorroboratemanagements
financialstatementassertionsare
performedwhenconsideringinternal
controlandforsubstantivetestsof
transactions.SeeAU329forinformation
onanalyticalprocedures.
21. (c)Therequirementistodetermine
themostpredictablerelationship
forpurposesofanalytical
proceduresappliedassubstantive
tests.Answer(c)iscorrectbecause
AU329indicatesthatrelationships
involvingincomestatement
accountstendtobemore
predictablethanrelationships
involvingonlybalancesheet
accounts.Answer(a)isincorrect
because,asindicated,relationships
involvingincomestatementsare
consideredmorepredictable.
Answer(b)isincorrectbecause
relationshipsinvolvingtransactions
subjecttomanagementdiscretion
Forexample,managementmightincur
maintenanceexpenseratherthanreplace
plantandequipment,ortheymaydelay
advertisingexpenditures.Answer(d)is
incorrectbecauseprioryeardatais
sometimesnotareliablepredictorofsub
sequentyearsdata.
22. (c)Therequirementistoidentifya
basicpremiseunderlyingthe
applicationofanalytical
procedures.Answer(c)iscorrect
because,asindicatedinAU329,a
basicpremiseunderlyingthe
applicationofanalyticalprocedures
isthatplausiblerelationships
amongdatamayreasonablybe
expectedtoexistandcontinuein
theabsenceofknownconditionsto
thecontrary.Answer(a)isincorrect
becausethestudyoffinancialratios
isanapproachtoidentifyingun
usualfluctuations,notanacceptable
alternativetoinvestigatingthem.
Answer(b)isincorrectbecause
analyticalproceduresmaybeeither
statisticalornonstatistical.Answer
(d)isincorrectbecauseanalytical
proceduresmaybeusedas
substantivetests,andmayresultin
modificationofthescopeoftestsof
balancesandtransactions.
23. (a)Therequirementistoidentify
thestagesofanauditforwhich
theuseofanalyticalprocedures
isrequired.AU329requiresthe
useofanalyticalproceduresat
boththeplanningandoverall
reviewstagesoftheaudit,butnot
asasubstantivetest.
24. (b)Therequirementisto
determinethereplythatwould
facilitateanauditorsanalytical
procedures.Answer(b)is
correctbecauseuseofastandard
costsystem(aformofbudgeting)
producesvariancereportsthat
willallow
140
MODULE4RESPONDINGTORISKASSESSMENT
theauditortocomparethefinancial
informationwiththestandardcostsystem
datatoidentifyunusualfluctuations.See
AU329fortheapproachused.Answer(a)
isincorrectbecausesegregatingobsolete
inventorybeforetheinventorycountis
relatedtotheauditorsphysicalinventory
observationandwillnotnecessarilyaffect
analyticalprocedures.Answer(c)is
incorrectbecausecorrectingamaterial
weaknessininternalcontrolbeforethe
beginningoftheauditgenerallywillhave
minimal,ifany,effectonthehistorical
informationusedforanalyticalprocedures.
Answer(d)isincorrectbecausedatafrom
independentsourcesoutsidetheentityis
morelikelytobereliablethanpurely
internalsources.
25. (c)Therequirementistoidentify
themostlikelyeffectonanauditof
havingperformedanalytical
proceduresintheoverallreview
stageofanauditwhichsuggestthat
severalaccountshaveunexpected
relationships.Answer(c)iscorrect
becausewhenunexpected
relationshipsexist,additionaltests
ofdetailsaregenerallyrequiredto
determinewhethermisstatements
exist.Answer(a)isincorrectbe
causeirregularities(fraud)mayor
maynotexist.An
swer(b)isincorrectbecauseinternal
controlactivitiesmayormaynotbe
operatingeffectively.Answer(d)is
incorrectbecauseordinarilythesituation
neednotbecommunicatedtotheaudit
committee.
26. (b)Therequirementistoidentify
thecomparisonanauditormost
likelywouldmakeinevaluating
anentityscostsandexpenses.
Answer(b)iscorrectbecause
payrollexpenseisanincome
statementexpenseandbecauseit
maybeexpectedtohavea
relationshipwiththatoftheprior
year.Answer(a)isincorrect
becausetheaccountsreceivable
accountisnotacostorexpense.
Answer(c)isincorrectbecause
comparingbudgetedsaleswith
actualsalesofthecurrentyearis
morelikelytobeperformedthan
comparingbudgetedsaleswith
thoseofprioryears.Answer(d)is
incorrectbecausecomparingthe
budgetedcurrentyearswarranty
expensewiththecurrentyears
contingentliabilitiesislessdirect
thanthatinanswer(b),and
becauseonewouldbemorelikely
tocomparecurrentyearbudgeted
warrantyexpensewithactual
warrantyexpense.
27. (c)Therequirementistoidentifythebest
individualtoperformanalyticalprocedures
intheoverallreviewstageofanaudit.At
thisstageofanaudittheobjectiveof
analyticalproceduresistoassistthe
auditorinassessingtheconclusions
reachedandintheevaluationoftheoverall
financialstatementpresentation.Answer
(c)iscorrectbecauseanexperienced
individualwithbusinessandindustry
knowledgeislikelytobeabletofulfillthis
function.Answer(a)isincorrectbecausea
staffaccountantwhohasperformedthe
substantiveauditingproceduresmaynotbe
abletoobjectivelyperformtheanalytical
procedureandmaynothavethenecessary
experiencetoperformthefunction.Answer
(b)isincorrectbecausethemanaging
partneroftheofficemaynotbeclose
enoughtotheaudittoperformthefunction
effectively.Answer(d)isincorrect
becausetheindividualinchargeofquality
controlandthepeerreviewprogramshould
beasindependentaspossibleoftheaudits
heorsheisconsidering.SeeAU329for
guidanceonanalyticalprocedures.
B.1.b.TestsofDetailsofTransactions
andBalances
28.(b)Therequirementistoidentifythe
bestexampleofasubstantivetest.Answer
(b)iscorrectbecauseconfir
mationofbalancesofaccountsreceivable
willprovideatestoftheendingaccount
balanceandisthereforeadetailedtestofa
balance,atypeofsubstantivetest.Answers
(a)and(c)areincorrectbecauseexamining
approvalofcashdisbursementsand
comparisonofsignaturesoncheckstoalist
ofauthorizedchecksignersaretestsof
controls.Answer(d)isincorrectbecause
flowchartingaclientscashreceiptssystemis
amethodusedtodocumenttheauditors
understandingofinternalcontrol.
29. (c)Therequirementistoidentifythe
objectiveoftestsofdetailsoftransactions
performedassubstantivetests.Answer(c)
iscorrectbecauseSAS110statesthatthe
objectiveoftestsofdetailsoftransactions
performedassubstantivetestsistodetect
materialmisstatementsinthefinancial
statements.Answer(a)isincorrectbecause
whileperformingtestsofdetailsof
transactionsassubstantivetestscomplies
withgenerallyacceptedauditingstandards,
thisisnottheirobjective.Answers(b)and
(d)areincorrectbecauseneitherattaining
assuranceaboutthereliabilityoftheac
countingsystemnortheevaluationofthe
operatingeffectivenessofmanagements
policiesandproceduresaretheobjectiveof
testsofdetailsoftransactionsperformedas
substantivetests.
30. (c) The requirement is to find
the statement which describes
substantiveaudittests. Answer
(c) is correct because
substantivetestsaredefinedas
testsoftransactions,directtests
of financial balances, or
analyticalprocedures.
Answer(a)isincorrectbecausesubstantive
testsmaynotbeeliminatedduetothe
limitationsofinternalcontrol.Answer(b)
isincorrectsincesubstantivetests
primarilydirectlytestendingfinancial
statementbalances,notsubsequent
events.Answer(d)isincorrectbecause
substantive
testsdecreasewithincreasedrelianceon
internalcontrol.
31.(c)Therequirementistodeterminethe
accountforwhichtheauditorismostlikelyto
performextensivetestsforpossible
understatement.Ananalysisofpastaudits,in
whichexistingfinancialstatementerrorswere
notdiscoveredpriortotheissuanceofthe
financialstatements,revealsthatthegreat
majorityoftheerrorsresultedinoverstated
profits.Therefore,therisktoaCPAisthatthe
clientisoverstatingprofits.Answer(c)is
correctbecauseitistheonlyitemwhose
understatementresultsinoverstatedprofits.
Answers(a),(b),and(d)areincorrectbecause
understatementoftheseitemswouldresultin
understatedprofits.
B.2.PreparingSubstantiveTestAudit
Programs
32. (d)Therequirementisto
determinethemostlikely
approachforauditingthe
statementofcashflows.Answer
(d)iscorrectbecausethe
statementofcashflowsincludes
accountsconsideredduringthe
auditofthebalancesheetand
incomestatementsand,
accordingly,themostfrequent
approachistoreconcileamounts.
Answers(a),(b),and(c)areall
incorrectbecausetheysuggest
approachesnottypicallyfollowed
whenauditingthestatementof
cashflows.
33. (c)Therequirementistodetermine
thedirectionofaudittestingto
determinewhethertransactions
havebeenrecorded.Answer(c)is
correctbecausetodetermine
whethertransactionshavebeen
recordedtheauditorwilltestfrom
theoriginalsourcedocumentsto
therecordedentries.Answers(a),
(b),and(d)areincorrectbecause
whentestingfromthegeneral
ledger,theadjustedtrialbalance,or
from
MODULE4RESPONDINGTORISKASSESSMENT
generaljournalentriestheauditoris
dealingwiththeentriesthathavebeen
recorded,notwhetheralltransactionshave
beenrecorded.
B.3.Documentation
34. (b)Therequirementistoidentify
thecorrectstatementconcerning
thedeletionofaudit
documentation.Answer(b)is
correctbecauseaftertheauditfile
hasbeencompleted(ordinarily60
daysorlessaftertheissuanceof
theauditreport),noportionsof
auditdocumentationshouldbe
deleted.Answer(a)isincorrect
becauseaftercompletionofthe
auditfilenodocumentation
shouldbedeletedordiscarded.
Answer(c)isincorrectbecause
professionalskepticismisnotthe
basisfordeterminingdeletions.
Answer(d)isincorrectbecause
priortothefilecompletiondate
mostsupersededdocumentation
maybedeleted(anexceptionis
thatinformationthatreflectsa
disparatepointofviewshouldbe
retained).
35. (a)Therequirementisto
determinehowlongaudit
documentationmustberetained.
Answer(a)iscorrectbecause
SAS103requiresthattheybe
maintainedaminimumoffive
years.Answers(b),(c)and(d)
allpresentother,incorrecttime
periods.
36. (a)Therequirementistoidentify
themostlikelypairofaccountsto
beanalyzedonthesameworking
paper.Answer(a)iscorrect
becauseanauditorwilloften
considerinterestincomewith
notesreceivablebecausethe
interestisearnedonthosenotes
andthereforecloselyrelated.An
swer(b)isincorrectbecause
interestreceivablerelatestoan
assetaccount(notesreceivable)
whileaccruedinterestpayable
relatestoaliabilityaccount
(notespayable)andaccordingly
onewouldexpectseparate
workingpapers.Answer(c)is
incorrectbecausenotespayable
andreceivableareentirely
separateaccounts.Answer(d)is
incorrectbecauseinterest
incomerelatestointerestbearing
securitieswhileinterestexpense
relatestodebtaccounts.
141
37. (a)Therequirementistoidentify
aprimarypurposeofanauditors
workingpapers.SAS103states
thatworkingpapersservemainly
toprovidetheprincipalsupport
fortheauditorsreportandtoaid
theauditorintheconductand
supervisionoftheaudit.
38. (c)Therequirementistoidentifytheleast
likelyitemtobeincludedinthepermanent
fileofanauditorsworkingpapers.Answer
(c)iscorrectbecausepermanentfiles
includeinformationaffectinganumberof
yearsaudits,andtheworkingtrialbalance
relatesmostdirectlytothecurrentand,toa
limitedextent,thesubsequentyearsaudit.
Answers(a),(b),and(d)areallincorrect
becausebondindentureagreements,lease
agreements,andaflowchartofinternal
controlaffectmoreyearsauditsthandoes
aspecificyearsworkingtrialbalance.
39. (c)Therequirementisto
determineadifferencebetween
anauditorsworkingtrialbalance
andfinancialstatementswithout
footnotes.Answer(c)iscorrect
becauseaworkingtrialbalance
includescolumnsfor
reclassificationandadjustments.
Answers(a),(b),and(d)areall
incorrectbecausewhilethey
suggestinformationthatmightbe
includedonaworkingtrial
balance,theywillnotbeincluded
intheformofadditional
columns.
40. (d)SAS103statesthatthedegree
ofdocumentationforaparticular
audit area should be affected by
(1)therisk
incorrectbecauseaninterbank
transferschedulesummarizes
transfersbetweenbanksamong
accounts.Answer(b)isincorrect
becausethetermcarryforward
scheduleisnotfrequentlyused.
Answer(c)isincorrectbecause
supportingschedulespresentthe
detailssupportingtheinformation
onaleadschedule.Forexample,
adetailedbankreconciliationfor
acashaccountmightserveasa
supportingscheduleforan
accountonthecashleadschedule.
41. (b)Therequirementistoidentify
therequireddocumentationinan
audit. Answer (b) is correct
because
SAS108requiresawrittenauditprogram
settingforthindetailtheprocedure
44. (c)Therequirementistoidentifythe
necessarytoaccomplishtheengagements
documentationthatisrequiredforanaudit
objectives.Answer(a)isincorrectbecause
inaccordancewithgenerallyaccepted
whileflowchartsandnarrativesare
auditingstandards.Answer(c)iscorrect
acceptablemethodsofdocumentingan
becauseSAS103requiresthattheworking
auditorsunderstandingofinternalcontrol,
papersshowthattheaccountingrecords
theyarenotrequired.Answer(c)is
agreeorreconcilewiththefinancial
incorrectbecauseaplanningmemorandum
statements.Answer(a)isincorrectbecause
isnotrequired.Answer(d)isincorrectbe
neitheraflowchartnoraninternalcontrol
causecompletionofaninternalcontrol
questionnaireisrequired.Answer(b)is
questionnaireisnotrequired.
incorrectbecausetheProfessional
Standardsdonotrequiretheuseofan
42. (a)Therequirementistoidentify
engagementletter.Answer(d)isincorrect
afactorthatwouldmostlikely
becausewhencontrolriskisassessedatthe
affecttheauditorsjudgment
maximumlevel,theauditors
aboutthequantity,type,and
understandingofinternalcontrolneedsto
contentoftheworkingpapers.
bedocumented,butthebasisforthe
Answer(a)iscorrectbecausethe
conclusionthatitisatthemaximumlevel
ProfessionalStandardsstate
neednotbedocumented.
thattheassessedlevelofcontrolriskwill
affectthequantity,typeandcontentof
45. (b)Therequirementistoidentify
workingpapers.SAS103providesalisting
thepointatwhichnodeletionsof
ofthisandotherfactors.Forexample,the
auditdocumentationareallowed.
quantity,typeandcontentofworking
Answer
paperswillbeaffectedbywhethertestsof
(b)iscorrectbecausetheprofessional
controlshavebeenperformed.
standardsindicatethatauditdocumentation
43. (d)Therequirementistoidentify
thetypeofauditworkingpaper
thatreflectsthemajorcomponents
ofanamountreportedinthe
financialstatements.Answer(d)
iscorrectbecauseleadschedules
aggregatethemajorcomponents
tobereportedinthefinancial
statements.Answer(a)is
maynotbedeletedafterthedocumentation
completiondate.Answer(a)isincorrect
becausedocumentationmaybedeleted
betweentheclientsyearenddateandthe
documentationcompletiondate.Answer(c)is
incorrectbecausethelastdateofsignificant
fieldworkispriortothedocumentation
completiondate.Answer(d)isincorrect
becausethereportreleasedateisupto60
days
MODULE4RESPONDINGTORISKASSESSMENT
142
priortothedocumentationcompletion
date;45daysforissuer(public)
companyaudits.
46. (b)Therequirementistodeterminethetype
ofauditorthatshouldbeabletounderstand
auditdocumentationofthenature,timing,
extent,andresultsofauditprocedures
performed.Answer(b)iscorrectbecause
PCAOBStandard3requiresthataudit
documentationbeunderstandabletoan
experiencedauditorhavingnoprior
connectionwiththeengagement.Answer
(a)isincorrectbecausetherequirementis
notlimitedtoauditteammembers.Answer
(c)isincorrectbecausetherequirementis
morelimitedthantoanycertifiedpublic
accountant.Answer(d)isincorrectboth
becausethereisnocertificationofapeer
reviewspecialistandbecausethisisnota
requirement.
47. (c)Therequirementistoidentify
theperiodforwhichaudit
documentationshouldberetained
forissuer(public)company
audits.Answer(c)iscorrect
becausePCAOBStandard3
requiresthatauditdocumentation
beretainedforthelongerof
sevenyearsortheperiodrequired
bylaw.Answer(a)isincorrect
bothbecauseofthesevenyear
requirement,andbecauseitisthe
longerofsevenyearsorthe
periodrequiredbylaw.Answer
(b)isincorrectbecausewhile
sevenyearsisthegeneral
requirement,alongerperiodmay
berequiredbylaw.Answer(d)is
incorrectbecauseaudit
documentationneednotbe
retainedindefinitely.
C.1.EvidenceCash
48. (b)Therequirementistoidentify
theinformationthatanauditor
usuallyconfirmsononeform.
Answer(b)iscorrectbecausethe
standardformtoconfirmaccount
balanceinformationwith
financialinstitutionrequests
informationonboththecashin
bankandcollateralforloans.An
swers(a),(c),and(d)areall
incorrectbecausetheysuggest
pairsofinformationthatarenot
usuallyconfirmedononeform.
49. (d)Therequirementistodeterminea
reasonthattheusefulnessofthestandard
bankconfirmationrequestmaybelimited.
Answer(d)iscorrectbecausethebank
employeewhocompletestheformoften
willnothaveaccesstoallthefinancial
relationshipsthatthebankhaswiththe
client.Answer(a)isincorrectbecausebank
employeeswhocompletetheformrealize
thattheymayverifyconfidentialin
formationwiththeauditor.Answer(b)is
incorrectbecausewhileitiscorrectthatthe
employeewhocompletestheconfirmation
formwillnotgenerallyinspecttheaccuracy
ofthebankreconciliation,thisdoesnot
limittheconfirmationsusefulness.Answer
(c)isincorrectbecausetheemployeewho
completestheformdoesnotneedtohave
accesstotheclientscutoffbankstatement
tocompletetheconfirmation.
50. (b)Therequirementisto
determinethetypeofevidence
thatislikelytoresultinan
auditorlimitingsubstantive
audittestsofsalestransactions
whencontrolriskisassessedas
lowfortheoccurrenceassertion
forsales.Answer(b)iscorrect
becauseanauditormayanalyze
thecompletenessofsalesusing
cashreceiptsandaccounts
receivable(forexample,an
auditormayaddyearendre
ceivablestocashreceiptsandsubtract
beginningreceivablestoobtainanestimate
ofsales).Answer(a)isincorrectbecause
theopeningandclosinginventorybalances
willonlyprovideindirectevidenceonsales
throughcalculationofthecostofgoods
sold.Answer(c)isincorrectbecausewhile
shippingasofyearendwillhelpassurean
accuratecutoffof
sales,thereceivingactivityhasnonecessary
relationshiptothesalesfigure.Answer(d)is
incorrectbecausewhilethecutoffofsales
willprovideevidenceonthecompletenessof
sales,thepurchasesportionofthereplyisnot
appropriate.
representdepositsintransitat
December31,2001.Depositsin
transitarethosethathavebeen
senttothebankpriortoyearend,
buthavenotbeenreceivedbythe
bankasofyearend.Answer(b)
iscorrectbecausebothcheck
#101andcheck#303havebeen
disbursedperbooksasofyear
end,buthavenotyetbeen
receivedbythebankasofDe
cember31.Checks#202and
#404havebeenreceivedbythe
bankasofyearendand
accordinglyarenotintransit.
Answer(a)isincorrectbecause
check#202hasbeenreceived
beforeyearend.Answer(c)is
incorrectbecausebothchecks
#202and#404havebeen
receivedbeforeyearend.Answer
(d)isincorrectbecausecheck
#404hasbeenreceivedbefore
yearend.
51. (b)Therequirementistodeterminethetwo
checksthatmightindicatekiting,aformof
fraudthatoverstatescashbysimultaneously
includingitintwoormorebankaccounts.
Answer(b)iscorrectbecausechecks#202
and#404includecashintwoaccountsat
yearend.Thecashrepresentedbycheck
#202isincludedinbothStateBankand
CountyBankcashasofDecember31.This
isbecauseitsreceiptisrecordedpriorto
yearend,butitsdisbursementisrecorded
afteryearend.(Forthecashreceipts
journaltoremaininbalancepriortoyear
end,someaccountmusthavebeencredited
onDecember30tooffsetthedebittocash.)
Check#404alsorepresentsasituationin
whichthecashisincludedintwoaccounts
53. (c)Therequirementistoidentifywhy
asofyearend;thecheckmayrepresenta
auditorstracebanktransfersforthelast
situationinwhichashortageintheaccount
partoftheauditperiodandthefirstpartof
isconcealedthroughdepositofthecheck
thesubsequentperiod.Answer(c)is
thatisnotrecordedonthebooksatyear
correctbecauseauditorsuseabanktransfer
end.Check#101doesnotresultina
scheduletoanalyzetransferssoastodetect
misstatementofcashsincethebooks
kitingthatoverstatescashbalances.
recordedboththedebitandcreditportions
Answers(a)and(b)areincorrectbecause
oftheentrybeforeyearend,whileboth
theprocessofanalyzingtransfersisnotan
banksrecordedthemafteryearend.Check
efficientwaytodeterminewhetherthecash
#303representsasituationinwhichfunds
receiptsjournalwasheldopenorwhenthe
aredisbursedontheFederalaccountasof
yearsfinalchecksweremailed.Auditors
yearend,butnotreceivedintothe
useabankcutoffstatementratherthana
Americanaccount(perbankorperbooks)
banktransferscheduletohelpdetectthese
untilafteryearend;check#303
situations.Answer(d)isincorrectbecause
accordinglyunderstatescashandthenature
theprocessofanalyzingtransfersis
ofthedebitfortheentryonDecember31is
unlikelytoidentifyanyunusualpayments
unknown.Answer(a)isincorrectbecause
orreceiptsfromrelatedparties.
neithercheck#101nor#303overstates
cash.Answer(c)isincorrectbecausecheck
54. (d)Therequirementistodetermine
#101doesnotoverstatecash.Answer(d)is
thesourceofevidencewhichdoes
incorrectbecausecheck#303understates
notcontaininformationonthe
cash.
52. (b)Therequirementisto
determinethecheckswhich
balanceperbankinabank
reconciliation.Answer(d)iscorrect
MODULE4RESPONDINGTORISKASSESSMENT
becausethegeneralledgercontainsonly
theclientscashbalance,notthebalance
perbank.Answer(a)isincorrectbecause
thebeginningbalanceonacutoffstatement
representstheyearendbankbalance.
Answer(b)isincorrectbecausetheprimary
purposeofayearendbankstatementisto
presentinformationonthebalanceper
bank.Answer(c)isincorrectbecausethe
firstquestiononastandardbank
confirmationformrequestsinformationon
theyearendbalanceperbank.
143
notrequest,norexpect,the
financialinstitutiontoconducta
comprehensive,detailed,search
ofitsrecordsforotheraccounts.
Answer(a)isincorrectbecausea
standardconfirmationrequest
willnotdetectkiting,a
manipulationcausinganamount
ofcashtobeincluded
simultaneouslyinthebalanceof
twoormorebankaccounts.
Answer(c)isincorrectbecause
bankstatementsavailablefrom
theclientallowtheCPAto
prepareaproofofcash.Answer
(d)isincorrectbecausethe
standardformdoesnotrequest
informationaboutcontingent
liabilitiesandsecured
transactions.
55. (b)Therequirementistoidentifythecash
transferwhichwillresultinamisstatement
ofyearendcash.Answer(b)iscorrect
becausethereceiptisrecordedonthebooks
priortoyearend,whilethedisbursementis
recordedsubsequenttoyearend.Therefore,
thecashonthebooksisoverstated.
58. (c)Therequirementistodeterminethe
Answers(a),(c),and(d)areincorrect
assertion(orassertions)beingtestedbya
becausetheydonotrevealacutofferror.
testofacontrolinwhichanauditor
Answer(a)isincorrectbecauseboththe
observesthemailingofmonthlystatements
disbursementandreceiptarerecordedon
toaclientscustomersandreviews
thebookspriortoyearend;notethatone
evidenceoffollowuponerrorsreportedby
wouldexpecttoseeanoutstandingcheck
thecustomers.Answer(c)iscorrect
onthedisbursingbankreconciliationasof
becauseobservingthemailingofmonthly
yearend.Answer(c)isincorrectbecause
statementsandfollowupoferrorswill
boththedisbursementandreceiptare
provideevidencetotheauditorasto
recordedonthebookspriortoyearend;
whether
onewouldexpectthedisbursingbank
thereceivablesexistatagivendate;thetests
reconciliationtoshowanoutstanding
donotdirectlyaddressthepresentationand
checkandthereceivingbanktoshowa
disclosureassertionsincelittleevidenceis
depositintransitasofyearend.Answer(d)
obtainedaboutwhetherfinancialstatement
isincorrectbecausetheentiretransaction
componentsareproperlyclassified,
isrecordedafteryearend.
56. (c)Therequirementisto
determineanapproachfor
detectingtheconcealingofacash
shortagebytransportingfunds
fromonelocationtoanotheror
byconvertingnegotiableassets
tocash.Answer(c)iscorrect
becausethetimingofthe
performanceofauditing
proceduresinvolvestheproper
synchronizingoftheirapplication
andthuscomprehendsthe
possibleneedforsimultaneous
examinationof,forexample,cash
onhandandinbanks,securities
owned,bankloans,andother
relateditems.
57. (b)Therequirementistoidentify
theprimarypurposeofsendinga
standardconfirmationrequestto
financialinstitutionswithwhich
theclienthasdonebusiness
duringtheyear.Answer(b)is
correctbecauseCPAsgenerally
providetheaccountinformation
ontheformandaskforbalance
corroboration.Theform
explicitlystatesthattheCPAsdo
described,anddisclosed.
SeeSAS106foradiscussionofthe
variousfinancialstatementassertions.
Answer(a)isincorrectbecausethe
presentationanddisclosureassertionis
notaddressed.Answer(b)isincorrect
becausethepresentationanddisclosure
assertionisnotaddressedandbecausethe
existenceoroccurrenceassertionis
addressed.Answer(d)isincorrectbecause
theexistenceoroccurrenceassertionis
addressed.
59. (b)Therequirementistodeterminethe
mostlikelyauditstepsummarizedbythe
tickmarkplacedunderdatedisbursedper
bank.Answer(b)iscorrectbecausethe
checkswerewritteninDecemberbut
clearedinJanuaryandshouldthereforebe
listedasoutstandingontheyearend
outstandingchecklistoftheapplicable
bankreconciliation.Answer(a)isincorrect
becausethetickmarksarebesidethedate
perbank,andnotperbooks.Answer(c)is
incorrectbecausetheDecembercash
disbursementsjournal,andnottheJanuary
cashdisbursementsjournal,willinclude
thesedisbursements.Answer(d)is
incorrectbecausetheyearendbank
confirmationsdonotincludeinformation
onoutstandingchecks.
60. (a)Therequirementisto
determinethemostlikelyaudit
stepsummarizedbythetickmark
placedunderdatedepositedper
bank.Answer(a)iscorrect
becausedepositsrecordedonthe
booksasof12/31shouldbe
includedasdepositsintransiton
theapplicablebank
reconciliation.Answer(b)is
incorrectbecausethetickmarkis
placedbesidethebank
column,andnotthebooks
column.Answer(c)isincorrect
becausetheDecembercash
receiptsjournal,andnotthe
Januarycashreceiptsjournal
shouldincludethedeposit.
Answer(d)isincorrectbecause
theyearendbankconfirmations
willnotincludedepositsin
transit.
C.2.EvidenceReceivables
61. (a)Therequirementistoidentifythe
correctstatementconcerningtheuseof
negativeconfirmationrequests.Answer(a)
iscorrectbecauseAU330statesthat
unreturnednegativeconfirmationrequests
rarelyprovidesignificantevidence
concerningfinancialstatementsassertions
otherthancertainaspectsoftheexistence
assertion.Answer(b)isincorrectbecause
positive,notnegative,confirmation
requestsarenormallyusedwhenalow
levelofdetectionriskistobeachieved.
Answer(c)isincorrectbecausealternative
proceduresarenotgenerallyperformedon
unreturnednegativeconfirmationrequests
sinceitisassumedthattherespondentdid
notreplybecauseofagreementwiththe
balanceontheconfirmationrequest.
Answer(d)isincorrectbecause
respondentsmaynotreplywhen
misstatementsareintheirfavor.
62. (c)Therequirementistoidentify
themostlikelyactiontakenbyan
auditorwhennoreplyisreceived
topositiveconfirmationrequests.
Answer(c)iscorrectbecause
askingtheclienttocontact
customerstoaskthatconfirmation
requestsbereturnedmayincrease
responserates.Answer(a)is
incorrectbecausethelackofa
replytoaconfirmationrequest
doesnotnecessarilyindicatethat
theaccountneedstobewritten
off.Answer(b)isincorrectbe
causeaccountsreceivable
confirmationsdealmoredirectly
withexistencethanwithvaluation
orcompletenessandbecause
alternativeproceduresmayprovide
theauditorwiththedesired
assurancewithrespecttothe
nonrespondents.
144
MODULE4RESPONDINGTORISKASSESSMENT
65. (a)Therequirementistodeterminewhen
alternativeproceduresshouldbe
performedinordertosubstantiatethe
existenceofaccountsreceivable.Answer
(a)iscorrectbecausetheauditorshould
employalternativeproceduresfor
nonresponsestopositiveconfirmationsto
satisfyhimself/herselfastotheexistenceof
accountsreceivable.Thoseproceduresmay
includeexaminationofevidenceof
subsequentcashreceipts,cashremittance
advices,salesandshippingdocuments,and
otherrecords.Answer(b)isincorrect
becausewithnegativeconfirmationsthe
debtorisaskedtorespondonlyifs/he
disagreeswiththeinformationonthe
confirmation;thus,noreplyisassumedto
indicateagreement.Answers(c)and(d)
areincorrectbecausewhileadditional
proceduresmayberequiredwhen
collectibilityisquestionable,alternative
proceduresarethoseusedinlieuof
confirmation.
66. (d)Therequirementistoidentify
themostlikelyalternate
procedurewhenreplieshavenot
beenreceivedtoeitherfirstor
secondaccountsreceivable
confirmationrequests.Answer
(d)iscorrectbecausethe
inspectionofshippingrecords
willprovideevidencethatthe
merchandisewasactuallyshipped
tothedebtor.Answer(a)is
incorrectbecause,areviewofthe
cashreceiptsjournalpriorto
yearendisunlikelytoprovide
evidenceonaccountrecordedas
unpaidasofyearend.Also,the
procedurewouldonlydetectone
specifictypeofmisstatement,
thatinwhichpaymentswere
recordedinthecashreceipts
journal,butnotcreditedtothe
customersaccounts.Answer(b)
isincorrectbecausethelackofa
replytotheconfirmationprovides
noparticularevidencethatthe
scopeofproceduresrelatedto
internalcontrolshouldbe
modified.Answer(c)isincorrect
becausethelackofareplyneed
notnecessarilyleadtoa
presumptionthattheaccountis
misstated.SeeAU330for
procedurestypicallyperformed
foryearendaccountsreceivable
confirmationrequestsforwhich
noreplyisreceived.
67. (d)Therequirementistoidentifythe
circumstancesinwhichuseofthenegative
formofaccountsreceivableconfirmation
mostlikelywouldbejustified.Negative
confirmationsareusedwhen(1)the
combinedassessedlevelofinherentand
controlriskislow,(2)alargenumberof
smallbalancesisinvolved,and(3)the
auditorhasnoreasontobelievethatthe
recipientsoftherequestsareunlikelyto
givethemconsideration.Positive
confirmationsareusedwhenthose
conditionsarenotmetaswellasinother
circumstancesinwhichitseemsdesirable
torequestapositiveresponse,suchas
whenaccountsareindispute.Answer(d)is
bestbecausesmallbalancesareinvolved
andfewaccountsareindispute.Answer(a)
isincorrectbecauseitreferstoasubstantial
numberofaccountsindisputeandsalesare
toafewmajorcustomers.Answer(b)is
incorrectbecauseitreferstoasubstantial
numberofaccountsindispute.Answer(c)
isincorrectbecauseitreferstosalestoa
fewmajorcustomers.
68. (a)Therequirementistoidentify
amethodtoreducetherisk
associatedwithacceptingemail
responsestoaccountsreceivable
confirmationrequests.Answer
(a)iscorrectbecausearesponse
bymailwillconfirmtheemail
response.Answer(b)isincorrect
becausewhilesuchsubsequent
cashreceiptswillordinarilybe
examined,thisrepresentsan
alternative,complementary
approachtoconfirmation.
Answer(c)isincorrectbecause
theauditorneednotconsidere
mailresponsestobe
confirmationswithexception.
Answer(d)isincorrectbecausea
secondrequestismorelikelyto
eliciteithernoresponseor
anotheremailresponse.
69. (b)Therequirementisto
determinethemostlikely
proceduretoreducetherisks
associatedwithacceptingfax
responsestorequestsfor
confirmationsofaccountsreceiv
able.Answer(b)iscorrect
becauseverificationofthe
sourcesandcontentsthrough
telephonecallswilladdress
whethertheinformationonthe
fax(whichmayhavebeensent
fromalmostanywhere)iscorrect.
Answer(a)isincorrectbecause
anexaminationoftheshipping
documentsislesscompletethan
isverificationoftheentire
balance.Answer(c)isincorrect
becausesuchfaxesneednotbe
treatedasnonresponses.Answer
(d)isincorrectbecauseinspection
ofthefaxesisunlikelytoreveal
forgeriesoralterations,even
whensuchcircumstanceshave
occurred.
70. (d)Therequirementisto
identifythecircumstancein
whichthenegativeformof
confirmationrequestmostlikely
wouldbeused.Answer(d)is
correctbecauseAU
330 statesthatnegativeconfirmations
maybeusedwhen(1)the
combinedassessedlevelof
inherentandcontrolriskislow
[answer(d)],(2)alargenumber
ofsmallbalancesisinvolved,and
(3)theauditorhasnoreasonto
believethattherecipientsofthe
requestsareunlikelytogivethem
consideration.Answer(a)is
incorrectbecausewhentheac
countsreceivableareimmaterial,
adecisionmaybemadetosend
noconfirmations.Answer(b)is
incorrectbecauseaninadequate
rateisnotanacceptablereasonto
sendnegativeconfirmations.
Answer(c)isincorrectbecause
negativeconfirmationsareonly
ofvaluewhentheauditorhasno
reasontobelievethatthe
recipientsoftherequestsare
unlikelytogivethem
consideration.
71. (a) The requirement is to
identify the circumstance in
whichanauditorwouldusethe
blank form of confirmations
(onewhichincludesnoamount
andaskstherespon
MODULE4RESPONDINGTORISKASSESSMENT
denttosupplytheamountdue)ratherthan
positiveconfirmations.Answer(a)is
correctbecauseifarecipientsimplysignsa
blankconfirmationandreturnsitthe
confirmationwillhavenoamountonitand
theauditorwillknowthatadditional
proceduresarenecessary.Answers(b)and
(c)areincorrectbecausethereisno
necessaryrelationshipbetweentheuseof
blankconfirmationsandsubsequentcash
receiptverificationdifficultyandanalytical
proceduresresults.Answer(d)isincorrect
becausewhenthecombinedassessedlevel
ofinherentriskandcontrolriskislowitis
unlikelytoleadtotheblankformof
confirmation.Infact,whenthatriskislow,
andwhenadequateothersubstantivetests
ofdetails,noconfirmationmaybe
necessary.SeeAU330forinformationon
theconfirmationprocess.
72. (d)Therequirementistoidentifythemost
likelyinformationthatwouldbeincludedina
clientsconfirmationletterthatisbeingused
toconfirmaccountsreceivablebalances
ratherthanindividualinvoices.Answer(d)is
correctsinceincludingdetailsoftheaccount
islikelytomakeiteasierforthecustomerto
respondinameaningfulmanner.Answer(a)
isincorrectbecausenosuchauditorprepared
letterwillbeincludedandbecauseonlyinthe
caseofthenegativeformofconfirmationdoes
anonresponseleadtoaninferencethatthe
accountbalanceiscorrect.Answer(b)is
incorrectbecauseconfirmationrequestsdonot
ordinarilyincludealettersuggestingthata
secondrequestwillbesent.Answer(c)is
incorrectbecausetheauditordoesnotenclose
aletterrequestingthattheinformationbe
supplied.SeeAU
145
confirmationofaccounts
receivable.Answer(a)iscorrect
becauseincludingalistofitems
orinvoicesthatconstitutethe
accountbalancemakesiteasier
forthepotentialrespondentto
reply.Answer(b)isincorrect
becausecustomerswithrelatively
largebalancesmayormaynotbe
morelikelytoreply.Answers(c)
and(d)areincorrectbecause
thereisnoresearchavailable
indicatingthatrequestingafaxor
emailreply,orthreateninga
secondrequestislikelyto
improveresponserate.
C.3.EvidenceInventory
75.(a)Therequirementistodeterminethe
financialstatementmostdirectlyrelatedto
theprocedureofmakinginquiries
concerningpossibleobsoleteorslow
movinginventory.Answer(a)iscorrect
becauseinquiriesconcerningpossible
obsoleteorslowmovinginventorydeal
withwhethertheinventoryisbeingcarried
atthepropervalue
andthisismostdirectlyrelatedtothe
valuationassertion.Theotherassertions
arelessdirectlyrelated.Answer(b)is
incorrectbecausetherightsassertiondeals
withwhetherassetsaretherightsofthe
entityandliabilitiesaretheobligationsof
theentityatagivendate.Answer(c)is
incorrectbecausetheexistenceassertion
dealswithwhetherassetsexistatagiven
date.Answer(d)isincorrectbecausethe
presentationassertiondealswithwhether
particularcomponentsofthefinancial
statementsareproperlyclassified.SeeSAS
106forinformationonthefinancial
statementassertions.
76. (d)Therequirementistoidentify
thetypeofomittedjournalentry
thatwouldresultininventorytest
countsthatarehigherthanthe
recordedquantitiesintheclients
perpetualrecords.Answer(d)is
correctbecauseafailuretorecord
salesreturnsresultsinasituation
inwhichtheitemisreturnedbya
customerandincludedinthe
inventorycount,butnotrecorded
intheperpetualrecords;
accordinglythetestcountsare
higherthantherecorded
quantities.Answer(a)is
incorrectbecausepurchase
discountsdonotaffectquantities
ininventory.Answers(b)and(c)
areincorrectbecauseafailureto
recordpurchasereturnsorsales
resultinasituationinwhichless
inventorywillbecounted(since
theitemsarenolongerphysically
ininventory)thanisrecordedon
theperpetualrecords.
77. (c)Therequirementistoidentifya
procedurethatwillprovideassurancethat
allinventoryitemsinaclientsinventory
listingschedulearevalid.Answer(c)is
correctbecausetracingfromtheinventory
listingscheduletoinventorytagsandto
theauditorsrecordedcountsheetswill
provideassurancethatthelisteditems
actuallyexist.Answer(a)isincorrect
becausetracingfrominventorytagsto
itemsintheinventorylistingscheduletests
thecompletenessoftheinventorylisting
sheet,notwhetheralloftheitemsitlists
arevalid.Answer(b)isincorrectbecauseit
doesnotdirectlytesttheclientsinventory
listingschedule.Answer(d)isincorrect
becausetracingitemslistedinreceiving
reportsandvendorsinvoicestothe
inventorylistingschedulewillprovide
assuranceonthecompletenessofthe
inventorylistingsheet;itwillalsobea
difficultproceduretoaccomplishduetothe
factthatanumberoftheseitemswillnotbe
ininventoryduetosales.SeeSAS106for
informationonthetestingofthevarious
financialstatementassertions.
78. (b)Therequirementistoidentify
thefactorthataverageinventory
isdividedintotocalculate
inventoryturnover.Answer(b)is
correctbecausetheaverage
inventoryisdividedintothecost
ofgoodssoldtocalculatethe
inventoryturnover.
79. (a)Therequirementistoidentifythe
auditingprocedurethatmostlikelywould
provideassuranceaboutamanufacturing
entitysinventoryvaluation.Answer(a)is
correctbecausetestingtheoverhead
computationwillprovideevidenceon
whetherinventoryhasbeenincludedinthe
financialstatementsattheappropriate
amount.Answer(b)isincorrectbecause
obtainingconfirmationofinventories
pledgedunderloanagreementsrelatesmore
directlytothepresentationassertion.
Answers(c)and(d)areincorrectbecause
reviewingshippingandreceivingcutoff
proceduresforinventoriesandtracingtest
countstotheinventorylistingrelatemore
directlytotheexistenceandcompleteness
assertions.
146
MODULE4RESPONDINGTORISKASSESSMENT
80. (b)Therequirementistoidentify
anactionthatanauditormighttake
whentheassessedlevelofcontrol
riskishighforinventory.Answer
(b)iscorrectbecauseahighlevel
ofcontrolriskwillgenerallyresult
inalowacceptablelevelof
detectionrisk,whichmaybe
achievedbychangingthetimingof
substantiveteststoyearend,
changingthenatureofsubstantive
teststomoreeffectiveprocedures,
and/orbychangingtheextentof
substantivetests.Answer(a)is
incorrectbecausecontrolriskhas
beenassessedandtestsofcontrols,
ifany,willalreadyhavebeencom
pleted.Answer(c)isincorrect
becauseayearendcountof
inventoryismoreappropriatewhen
controlriskishigh.Answer(d)is
incorrectbecausegrossprofittests
willgenerallyprovideless
assurancethanisrequiredin
circumstancessuchasthiswhen
controlriskisassessedatahigh
level.
81. (a)Therequirementistoidentifythe
financialstatementassertion(otherthan
presentationanddisclosure)mostdirectly
relatedtoanauditorsconclusionthatno
excessivecostsforidleplantwerecharged
toinventory.Answer(a)iscorrectbecause
theassertiondealswithwhethertheinven
toryhasbeenincludedinthefinancial
statementsattheappropriateamount,and
thereforethatnoexcessivecostswere
chargedtoinventory.Answer(b)is
incorrectbecausethecompleteness
assertiondealswithwhetherallinventory
itemsthatshouldbepresentedareso
included.Answer(c)isincorrectbecause
existencedealswithwhethertheinventory
actuallyexitsatthegivendate.Answer(d)
isincorrectbecauserightsdealwith
whethertheinventoryisownedbythe
client.Formoreinformationon
managementsfinancialstatement
assertions,seeSAS106.
82. (b)Therequirementistoidentifythe
financialstatementassertionmostdirectly
relatedtoanauditorstracingofinventory
testcountstotheclientsinventorylisting.
Answer(b)iscorrectbecausethe
completenessassertiondealswithwhether
alltransactionsareincluded.Tracingfrom
theinventoryitemsobservedtothe
inventorylistingwillhelpdetermine
whetherallthetransactionsareincluded
andtheinventorylistingiscomplete.
Answer(a)isincorrectbecausetherights
assertiondealswithwhetherassetsarethe
rightsoftheentityandthisisnotbeing
testedwhenanauditortracestestcountsto
aninventorylisting.Answer(c)is
incorrectbecauseexistencedealswith
whethertheinventoryexistedatthedateof
thecount.Totestexistencetheauditor
wouldsamplefromtheinventorylisting
andcomparequantitiestothetestcounts.
Answer(d)isincorrectbecausevaluation
dealswithwhethertheinventoryisproperly
includedinthebalancesheetatthe
appropriatedollaramountandthisisnot
beingtestedhere.SeeSAS
106 for more information on
managements financial state
mentassertions.
83. (d)Therequirementistodeterminethe
assertionmostdirectlyrelatedtoan
auditorsanalysisofinventoryturnover
rates.Answer(d)iscorrectbecausean
analysisofinventoryturnoverrateswill
providetheauditorwithevidenceonslow
moving,excess,defective,andobsolete
itemsincludedininventories.Theseitems
maybeimproperlyvalued.
84. (a) The requirement is to
determinewhichtypesofentries
will be supported when the
auditor examines receiving
reports. Answer (a) is correct
becausereceivingreportswillbe
prepared when goods are
received through purchase (as
recordedinthevoucherregister)
andwhengoodsare
receivedthroughsalesreturns(as
recordedinthesalesreturnsjournal).
Answers(b),(c),and(d)areincorrectbe
causeentriesinsalesjournalsresultin
itemsbeingshipped,notreceived.Note,
however,thatanswers(b),(c),and(d)are
partiallycorrectbecausethesalesreturns
journal,voucherregister,andcheck
registerallresultfromtransactions
relatedtothereceiptofgoods.
85.(c)Therequirementistoidentifythe
responsewhichdoesnotrepresentoneof
theindependentauditorsobjectives
regardingtheexaminationofinventory.
Answer(c)iscorrectbecauseverifying
thatallinventoryownedbytheclientison
handatthetimeofthecountisnotan
objective.Forexample,purchaseditemsin
transitatyearend,forwhichtitlehas
passed,shouldbeincludedininventory.
Similarly,inventoryoutonconsignment
shouldalsobeincludedininventory.
Answer(a)isincorrectbecauseproper
presentationofinventorypertainstothe
presentationanddisclosureassertionand
thereforewouldbesubjecttoauditor
verification.Answers(b)and(d)arein
correctbecauseproperaccountingfor
damagedandobsoleteitemsandproper
inventorypricingpertaintothevaluation
assertionandthereforewouldbesubjectto
auditorverification.SeeSAS106for
detailsonfinancialstatementassertions.
C.4.EvidenceInvestmentSecurities
86. (c)Therequirementisto
determinewhyanauditorshould
insistthataclientrepresentative
bepresentwhenheorshe
physicallyexaminessecurities.
Answer(c)iscorrectbecause
requiringthataclient
representativeacknowledgethe
receiptofthesecuritieswill
eliminateanyquestioncon
cerningtheCPAsresponsibility
foranysubsequentmis
placementormisappropriationof
thesecurities.Answer(a)is
incorrectbecausetheclients
representativewillnotingeneral
helptheCPAtodetectfraudulent
securities.Answers(b)and(d)
areincorrectbecausewhilethe
clientsrepresentativewillhelp
theCPAtogainaccesstothe
securitiesandmaycoordinate
theirreturn,thesearenotthe
auditorsprimarypurpose.
87. (c)Therequirementistoidentifythebest
procedureotherthaninspectiontoestablish
theexistenceandownershipofalongterm
investmentinapubliclytradedstock.
Answer(c)iscorrectbecauseconfirmation
ofthenumberofsharesownedthatareheld
byanindependentcustodianiseffectiveat
testingexistence.Answer(a)isincorrect
becauseauditorsdonotingeneral
correspondwiththeinvesteecompanyand
becausethatcompanymayormaynothave
detailedinformationontheidentityof
shareholdersatanypointintime.Answer
(b)isincorrectbecausewhileinspectionof
theauditedfinancialstatementsofthe
investeecompanymayprovidelimited
informationonvaluationoftheinvestment,
itdoesnotdirectlyaddressexistence;note
thatthisprocedureisoflimitedusehere
sincethestockispubliclytradedand
obtainingitsvaluethroughstockpricequo
tationsshouldnotbedifficult.Answer(d)
isincorrectbecausethisprocedure
addressesthevaluationofthesecurities.In
addition,underSFAS115,investmentsare
nolongercarriedatthelowerofcostor
market.SeeSAS106formoreinformation
onmanagementsfinancialstatement
assertions.
88. (c)Therequirementistodetermine
the best procedure when an
auditorhasbeenunabletoinspect
andcounta
MODULE4RESPONDINGTORISKASSESSMENT
147
accumulateddepreciationexpense.Answer
(b)iscorrectbecausedebitstoaccumulated
depreciationareproperlyrecordedupon
retirementofaplantasset.Answer(a)is
incorrectbecausechangingtheusefullives
ofplantassetsdoesnotaffectaccumulated
depreciation.Answer(c)isincorrect
becauseunderstatementoftheprioryears
depreciationexpensedoesnotresultinan
adjustmenttoaccumulateddepreciation.
Answer(d)isincorrectbecauseoverhead
allocationsdonotordinarilyaffectaccumu
lateddepreciation.
clientsinvestmentsecurities(heldina
safedepositbox)untilafterthebalance
sheetdate.Answer(c)iscorrectbecause
banksmaintainrecordsonaccesstosafe
depositboxes.Thus,theconfirmationofno
accessduringtheperiodwillprovidethe
auditorwithevidencethatthesecuritiesin
thesafedepositboxatthetimeofthe
countwerethoseavailableatyearend.
Answers(a)and(b)areincorrectbecause
thebankwillnotgenerallybeableto
providealistofsecuritiesaddedand
92. (a)Therequirementistoidentifythebest
removedfromthebox(typically,only
recordsonaccessaremaintainedbythe
procedurefortestingunrecorded
bank).Therefore,thebankwillhaveno
retirementsofequipment.Answer(a)is
informationonreconcilingitemsbetween
correctbecauseselectingitemsfromthe
thesubsidiaryledgerandthesecuritieson
accountingrecordsandattemptingto
hand.Answer(d)isincorrectbecauseitis
locatethemwillrevealunrecorded
theresponsibilityoftheauditorandthe
retirementswhentheitemcannotbe
client,notthebank,tocountthesecurities
located.Answer(b)isincorrectbecause
maintainedinasafedepositbox.
depreciationentrieswillcontinuewhen
retirementshavenotbeenrecorded.Answer
89.(a)Therequirementistodeterminethe
(c)isincorrect
mostlikelyuseofanalyticalprocedures
whentestinglongterminvestments.
Answer(a)iscorrectbecausethe
predictablerelationshipbetweenlongterm
investmentsandinvestmentincomecreates
asituationinwhichanalyticalprocedures
mayprovidesubstantialauditassurance.
Answer(b)isincorrectbecausethe
classificationbetweencurrentandnon
currentportfoliosmaybeexpectedto
fluctuateinanunpredictablemanneras
investmentgoalsandtheenvironment
change.Answers(c)and(d)areincorrect
becausethevaluationofmarketableequity
securitiesatthelowerofcostormarketand
unrealizedgainsorlossesdonotresultina
predictablerelationshiponwhichanalytical
proceduresmayprovideeffectiveresults.
C.5.EvidenceProperty,Plant,and
Equipment
90. (d)Therequirementistoidentifythe
accountwhoseanalysisisleastlikelyto
revealevidencerelatingtorecorded
retirementsofequipment.Answer(d)is
correctbecausethepurchasereturnsand
allowancesaccountdealswithreturnsand
allowancesforpurchasesofmerchandise,
notequipment.Answer(a)isincorrect
becauseanalysisofaccumulated
depreciationwillrevealtheretirement
throughchargesmadetotheaccumulated
depreciationaccount.Answer(b)is
incorrectbecausecompanieswillordinarily
modifyinsurancecoveragewhenassetsare
retired.Answer(c)isincorrectbecausethe
property,plant,andequipmentaccount
willreflecttheretirement.
91. (b)Therequirementistoidentifyalikely
explanationforasituationinwhich
significantdebitshavebeenpostedtothe
becausethedirectionofthetestis
incorrectsincebeginningwiththeitemis
unlikelytorevealasituationinwhichan
unrecordedretirementhasoccurred.
Answer(d)isincorrectbecausescanning
thegeneraljournalforrecordedentriesis
unlikelytorevealunrecordedretirements
ofequipment.
93. (d)Therequirementisto
determinewhyanauditor
analyzesrepairsandmaintenance
accounts.Answer(d)iscorrect
becauseclientsoftenerroneously
chargeexpendituresforproperty
andequipmentacquisitionsas
expensesratherthancapitalize
themasassets.Ananalysisof
repairsandmaintenanceaccounts
willrevealsucherrors.Answer
(a)isincorrectbecausewhile
auditorswillwanttodetermine
thatnoncapitalizableexpenses
forrepairsandmaintenancehave
beenrecordedintheproper
period,analyzingonlythe
recordedentriesisanincomplete
testsinceentriesoccurringafter
yearendwillalsoneedtobe
examined.Answer(b)is
incorrectbecauseprocedures
relatingtothepropertyand
equipmentaccountwillbe
performedtodeterminewhether
suchentrieshavebeenrecorded
inthe
properperiod.Answer(c)isincorrect
becauseanalyzingtherepairsand
maintenanceaccountsonlyconsiders
recordedentriesandnotwhetherall
noncapitalizableexpendituresforrepairs
andmaintenancehavebeenproperly
chargedtoexpense.
94. (c)Therequirementisto
determinetheinformationan
auditorismostlikelytoseek
fromtheplantmanager.The
plantmanagercomesintodayto
daycontactwiththemachinery
whenproducingaproduct;that
contactislikelytoprovide
informationonitsconditionand
usefulness.Answers(a)and(d)
areincorrectbecausetheplant
managerwillgenerallynothave
detailedknowledgeastotheade
quacyoftheprovisionfor
uncollectibleaccountsorthe
amountofinsurancewhichis
desirable.Answer(b)isin
correctbecausetheplantmanager
willhavelimitedknowledge
concerningphysicalinventory
observationproceduresandtheir
appropriateness.
95. (a)Therequirementistoidentify
thedocumentleastlikelyto
provideevidenceregarding
mortgageacquisitioncosts.
Deedsgenerallyconsistofalegal
conveyanceofrightstousereal
property.Frequentlythesales
priceisnotevenspecifiedandthe
relatedmortgageacquisitioncosts
aremuchlesslikelytobestatedin
adeed.Answer(b)isincorrect
becausecancelledcheckswould
provideverificationofmortgage
acquisitioncosts.Answer(c)is
incorrectbecausetheclosing
statementwouldprovidea
detailedlistingofthecostsof
acquiringtherealproperty,
includingpossiblemortgage
acquisitioncosts.Answer(d)is
incorrectbecauseexaminationof
interestexpensewouldalsorelate
tothemortgageacquisitioncosts.
96. (b)Therequirementistodetermine
theassertion(s)involvedwhenan
auditorisinspectingnewadditions
onalistofproperty,plant,and
equipment.Answer(b)iscorrect
becauseanauditorwhoinspects
newadditionsrelatingtoproperty
andequipmentbalancesaddresses
existenceoroccurrence,butnot
presentationanddisclosure;
presentationanddisclosurerelates
moredirectlytoproper
classificationandnotedisclosures
ratherthanaccountbalances.
C.6.EvidencePrepaidAssets
97.(a)Therequirementistodeterminethe
financialstatementassertionmostdirectly
relatedtotheprocedureofreviewingor
recomputingamortizationofintangible
assets.
148
MODULE4RESPONDINGTORISKASSESSMENT
Answer(a)iscorrectbecausethe
amortizationofintangibleassetsdealswith
whethertheaccountsareproperlyvalued,
thevaluationassertion.Theotherassertions
arelessdirectlyrelated.Answer(b)is
incorrectbecausetheexistenceor
occurrenceassertiondealswithwhether
assetsorliabilitiesexistatagivendateand
whetherrecordedtransactionshave
occurredduringagivenperiod.Answer(c)
isincorrectbecausethecompleteness
assertiondealswithwhetherall
transactionsandaccountsthatshouldbe
presentedinthefinancialstatementsareso
included.Answer(d)isincorrectbecause
therightsandobligationsassertiondeals
withwhetherassetsaretherightsofthe
entityandliabilitiesaretheobligationsof
theentityatagivendate.SeeSAS106for
informationonthefinancialstatement
assertions.
98.(c)Therequirementistodeterminethe
mostlikelyreasonfortheabsenceofthe
originalinsurancepolicyonplant
equipment.Answer(c)iscorrectbecause
theholderofthelienmayalsoincertain
circumstancesmaintaintheoriginal
insurancepolicy.Answer(a)isincorrect
becauseaninsurancepremiumwhichis
duebutnotrecordedisunlikelytoaccount
forthelackoftheoriginalinsurance
policy.Answer(b)isincorrectbecause
whilecoinsuranceprovisionsareoutlined
inthepolicy,theyareunlikelytobea
reasonthatthepolicyisnotavailablefor
inspection.Answer(d)isincorrect
becausethereisnoobviousrelationship
betweentheunderstatementofinsurance
expenseandthepresenceorabsenceofan
insurancepolicy.
C.7.EvidencePayables(Current)
99. (c)Therequirementistoidentifythebest
auditproceduresforidentifying
unrecordedliabilities.Answer(c)iscorrect
becauseunrecordedliabilitieseventually
becomedueandmustbepaid.Accordingly,
areviewofcashdisbursementsafterthe
balancesheetdateisaneffectiveprocedure
fordetectingunrecordedpayables.Answer
(a)isincorrectbecausetracingasampleof
accountspayablethathavebeenrecordedis
notlikelytoresultinidentificationof
unrecordedliabilities.Answer(b)is
incorrectbecausepurchaseordersissued
afteryearendwillnotresultinliabilitiesas
ofyearend.Answer(d)isincorrect
becausedisbursemententriesrecorded
beforeyearendgenerallyrelatetoaccounts
payablethathavebeenpaidbeforeyear
end.
100. (a)Therequirementistoidentify
theappropriatepopulationwhen
usingaccountspayable
confirmationsdirectedtowards
obtainingevidenceonthe
completenessassertion.Answer(a)
iscorrectbecausetoaddress
completenesstheauditorattempts
todeterminethatallaccountspay
ablearereflected,andacompany
potentiallymaybeliabletoanyof
itsvendors.Answer(b)isincorrect
becauseconfirmingbasedon
recordedamountsaddresses
existencemoredirectlythan
completeness.Answer(c)is
incorrectbecausebasingthesample
onpayeesafteryearendonlydeals
withthosepayablesthathavebeen
paidasofthatpoint.Answer(d)is
incorrectbecauseopeninvoicesare
alesscompletepopulationthanare
vendors.SeeAU330for
informationontheconfirmation
process,andSAS106for
informationonmanagements
financialstatementassertions.
101. (d)Therequirementisto
determinewhyconfirmationof
accountspayableisunnecessary.
Accountspayableareusuallynot
confirmedbecausethereisbetter
evidenceavailabletotheauditor,
(i.e.,examinationofcash
paymentssubsequenttothe
balancesheetdate).Iftheauditor
reviews
allcashpaymentsforasufficienttime
afterthebalancesheetdateforitems
pertainingtotheperiodunderauditand
findsnosuchpaymentswhichwerenot
recordedasliabilitiesatyearend,the
auditorisreasonablyassuredthatac
countspayablewerenotunderstated.
Answer(a)isanonsenseanswer.Answer
(b)isincorrectbecauseAPbalancescould
bepaidduringyearendauditworkafter
thebalancesheetdate.Answer(c)is
incorrectbecausewhetherornotlegal
actionhasbeentakenagainsttheclientis
irrelevanttotheconfirmationprocedure.
102. (c)Therequirementistoidentify
thesubstantivetesttobe
performedtoverifytheexistence
andvaluationofrecorded
accountspayable.Answer(c)is
correctbecausethevouchingof
variouspayableaccountsto
purchaseordersandreceiving
reportswillprovideevidencethat
thedebtwasincurredandthe
relatedgoodsreceived,thereby
providingevidenceonthe
existenceofthedebtandits
amount,orvaluation.Answer(a)
isincorrectbecausedetermining
whetherprenumberedpurchase
ordersareusedandaccounted
forrelatesmoredirectlytothe
completenesswithwhich
purchasesandaccountspayable
wererecorded.Answers(b)and
(d)areincorrectbecausethe
questionaddressestheexistence
andvaluationofrecorded
accountspayable,notunrecorded
payablesorpayableswithazero
balance.
103. (c)Therequirementistodetermine
managementsaccountspayableassertionthat
anauditorwillprimarilyfocuson.Experience
hasindicatedthatoverstatedincomeismore
ofariskthanisunderstatedincome.Answer
(c)iscorrectbecausethecompleteness
assertionfocusesuponwhetherpayableshave
beenomitted,therebyoverstatingincome.
Answer(a)isincorrectbecausetheexistence
assertiondealswithwhetherrecorded
accountspayableareoverstated,thereby
understatingincome.Answer(b)isincorrect
becausepayablesoftenrequirenoparticularly
troublesomepresentationsanddisclosures.
Answer(d)isincorrectbecausepayablesare
mostfrequentlysimplyvaluedatthecostof
therelatedacquisition.SeeSAS106formore
informationonmanagementsfinancial
statementassertions.
C.8.EvidenceLongTermDebt
104. (b)Therequirementistoidentify
alikelyreasonforarecorded
interestexpensethatseems
excessiveinrelationtothe
balanceinthebondspayable
account.Answer(b)iscorrect
becauseunderstatedbonds
payablewillresultinalower
accountbalancethanisproper
andtherebycreateasituationin
whichtheinterestexpense
appearsexcessive.Answers(a)
and(d)areincorrectbecausean
understateddiscountoran
overstatedpremiumonbonds
payableresultinsituationsin
whichtherecordedinterest
expenseseemslowerthan
expectedsincethenetbonds
payableareoverstated.Answer
(c)isincorrectbecause
understatements,not
overstatements,ofbondspayable
willresultinwhatappearstobe
anexcessiverateofinterest
expense.
105. (a)Therequirementistodeterminethe
financialstatementassertionmostdirectly
relatedtoanauditorsinspectionofloan
agreementsunderwhichanentitysin
ventoriesarepledged.Answer(a)iscorrect
becausethepresentationanddisclosure
assertiondealswithwhetherparticular
componentsofthefinancialstatementssuch
asloanagreementcovenantsareproperly
classified,described,anddisclosed.Theother
assertionsarelessdirectlyrelated.
MODULE4RESPONDINGTORISKASSESSMENT
Answer(b)isincorrectbecausethe
valuationorallocationassertiondealswith
whetherasset,liabilities,revenue,and
expensecomponentshavebeenincludedin
thefinancialstatementsattheappropriate
amounts.Answer(c)isincorrectbecause
theexistenceoroccurrenceassertiondeals
withwhetherassetsorliabilitiesexistata
givendateandwhetherrecorded
transactionshaveoccurredduringagiven
period.Answer(d)isincorrectbecausethe
completenessassertiondealswithwhether
alltransactionsandaccountsthatshouldbe
presentedinthefinancialstatementsareso
included.SeeSAS106forinformationon
thefinancialstatementassertions.
106. (c)Therequirementistoidentifya
procedureanauditorwouldperformin
auditinglongtermbondspayable.Answer
(c)iscorrectbecausecomparinginterest
expensewiththebondpayableamountwill
provideevidenceastoreasonableness.Such
aproceduremayrevealeitherinterestnot
expensedordebtnotproperlyrecorded.
Answer(a)isincorrectbecauseanalytical
procedureswillnotingeneralbeperformed
onbondpremiumsanddiscountssince
theseaccountsmayeasilybeverifiedby
examiningdetailsoftheentryrecordingthe
debtissuanceandanysubsequentamor
tization.Answer(b)isincorrectbecausean
examinationofthedocumentationofassets
purchasedwithbondproceedsisonly
necessarywhensuchauseofthefundsisa
requirementofthedebtissuance.Answer
(d)isincorrectbecauseconfirmationof
bondsoutstandingwilloftenbewiththe
trusteeratherthanwithindividual
bondholders.
107. (b)Therequirementisto
determinehowanauditorcanbest
verifyaclientsbondsinkingfund
transactionsandyearendbalance.
Answer(b)iscorrectbecause
confirmationwiththebond
trusteerepresentsexternally
generatedevidencereceived
directlybytheauditor.Such
evidenceisconsideredvery
reliable.Answer(a)isincorrect
becauseindividualholdersof
retiredbondswillhaveno
informationonactualbond
sinkingfundtransactionsoryear
endbalances.Answer(c)is
incorrectbecause,while
recomputinginterestexpense,
interestpayable,andamortization
ofbonddiscountorpremiumsare
desirableprocedures,theydonot
directlyaddressbondsinkingfund
transactionsandyearend
balances.Answer(d)issimilarto
149
answer(c)inthatitisdesirable
butdoesnotaddresstheactual
bondsinkingfundtransactions
andyearendbalance.
C.9.EvidenceOwnersEquity
108. (a)Therequirementisto
determinehowanauditor
ordinarilyobtainsevidenceof
stockholdersequitytransac
tions.Answer(a)iscorrect
becausetheboardofdirectors
will,ingeneral,authorize
changesinstockholdersequity.
Answer(b)islesscompletein
thatforsmallclientstheremay
benotransferagent,andbecause
thetransferagentdealsmost
directlywithtransfersof
outstandingstock.Answer(c)is
incorrectbecausecanceledstock
certificatesareordinarily
availableonlyforsmallclients.
Answer(d)isincorrectbecause
companiesdonotordinarily
haveatreasurystock
certificatebook.
109. (d)Therequirementistoidentify
themostlikelyauditprocedure,
inadditiontoanalytical
procedures,whencontrolriskfor
payrollisassessedaslow.
Answer(d)iscorrectbecause
accrualofpayrollatyearendis
notanentrymadefrequently
throughouttheyearand
accordinglyrecordingofthe
entryisoftennotcontrolledby
thepayroll
112. (d)Therequirementistoidentify
theprocedurethatismostlikely
whenanauditorisperformingtests
concerningthegrantingofstock
options.Answer(d)iscorrectbe
causeauthorizingtheissuanceof
stockoptionsisordinarilya
decisionmadebytheboardof
directors.Answer(a)isincorrect
becausetheSecretaryofStateof
thestateofincorporationwillnot
havethisinformationonstock
options.Answer(b)isincorrect
becausetheexistenceoftheoption
holdersisnotordinarilya
significantquestion.Answer(c)is
incorrectbecausestocktobeissued
relatingtooptionsmaybeeither
fromtreasurystockornew
issuances;accordingly,sufficient
treasurystockneednotbe
available.
113. (d)Therequirementistoidentify
theassertiontowhichdetermining
whethertherearerestrictionson
retainedearningsrelatesmost
directly.Answer(d)iscorrectbe
causesuchrestrictionswillresultin
disclosuresandthusthe
presentationanddisclosure
assertionismostdirectlybeing
verified.Answer(a)isincorrect
becausetheexistenceoroccurrence
assertionaddresseswhetherassets
orliabilitiesoftheentityexistata
givendateandwhetherrecorded
transactionshaveoccurredduringa
givenperiod.An
swer(b)isincorrectbecausethe
completenessassertionaddresseswhether
alltransactionsandaccountsthatshould
bepresentedinthefinancialstatements
aresoincluded.Answer(c)isincorrect
becausethevaluationorallocation
assertionaddresseswhetherasset,
liability,revenue,andexpense
componentshavebeenincludedinthe
financialstatementsatappropriate
amounts.SeeSAS106foradiscussion
offinancialstatementassertions.
150
MODULE4RESPONDINGTORISKASSESSMENT
114. (b)Therequirementistoidentify
theinformationanauditorshould
confirmwithaclientstransfer
agentandregistrar.Answer(b)is
correctbecausewhenaclientem
ploysatransferagentand
registrar,therewillbenostock
certificatebooktoexamine,and
accordingly,informationon
sharesissuedandoutstanding
shouldbeconfirmed.Answers
(a),(c),and(d)areincorrect
becausethetransferagentand
registraroftenwillnothave
informationondividend
restrictions,guaranteesof
preferredstockliquidationvalues,
andthenumberofsharessubject
toagreementstorepurchase.
115. (c)Therequirementisto
determinealikelystepinthe
auditprogramforretained
earnings.Thelegalityofa
dividenddependsinparton
whetherithasbeenproperly
authorized(statelawsdifferon
specificrequirements).Thus,the
auditormustdeterminethat
properauthorizationexists,as
bothcashandstockdividends
affectretainedearnings.Answer
(a)isincorrectsinceonlyamemo
entryisrequiredforastocksplit.
Answer(b)isincorrectbecause
thewritedownofanaccount
receivablewillnot,ingeneral,be
recordedinretainedearnings.
Answer(d)isincorrectbecause
gainsfromthedispositionof
treasurysharesarerecordedin
paidincapitalaccounts.
116. (c)Therequirementisto
determinewhenanauditorwould
bemostlikelytoperform
substantivetestsofdetailson
payrolltransactionsandbalances.
Answer(c)iscorrectbecause
analyticalproceduresresultin
furtherinvestigationwhen
unexpecteddifferencesoccur.
Thisinvestigationwillgenerally
involvesubstantivetestsofdetails
oftransactionsandbalances.AU
329providesdetailedinformation
onanalyticalprocedures.Answer
(a)isincorrectbecausea
substantialamountofaccrued
payrollexpenseasindicatedbya
cutofftestwillnotnecessarily
resultinadditionalsubstantive
tests.Answer(b)isincorrect
becausealowassessedlevelof
controlriskislikelytoresultin
lesssubstantivetesting.Answer
(d)isincorrectbecausethenature
ofaccruedpayrollexpensebeing
unpaidcommissionsneednot
necessarilyresultinmore
substantivetesting.
117. (a)Therequirementistodeterminea
sourceanauditorusestotestthe
reasonablenessofdividendincomefrom
investmentsinpubliclyheldcompanies.
Answer(a)iscorrectbecausedividend
recordbooksproducedbyinvestment
advisoryservicesprovidesummariesof
dividendspaidforvarioussecurities,andan
auditorisabletocomparethe
reasonablenessofaclientsrecorded
dividendincomefrominvestmentswiththis
information.Answers(b)and(c)are
incorrectbecauseauditorsdonot,in
general,determinethereasonablenessof
dividendincomebyexaminingstockin
denturesorstockledgers.Answer(d)is
incorrectbecausewhileannualfinancial
statementsofinvesteecompaniesmay
includesuchinformation,examiningsuch
financialstatementsisnotgenerallyan
efficientapproachfortestingthe
reasonablenessofdividendincome.Also,
thecurrentyearfinancialstatementsofthe
investeesoftenarenotavailablewhenthe
auditorisperformingthecurrentaudit.
C.10.Revenue
118.(c)Therequirementistoidentifythe
mostlikelyriskinvolvedwithabilland
holdtransactionatyearend.Answer(c)is
correctbecauseabillandholdtransaction
resultsintherecordingofasalepriorto
deliveryofthegoodsaccordingly,sales
maybeinappropriatelyrecorded.
Answer(a)isincorrectbecauseaccrued
liabilitiesarenotordinarilyaffectedby
billandholdtransactions.An
swers(b)and(d)areincorrectbecausean
absolutepurchasecommitmentandthe
assumingofriskandrewardrelatingtothe
productrepresentconditionswhich
increasethelikelihoodthatrecordingofa
saleforsuchatransactionisappropriate.
119.(b)Therequirementistoidentifythe
mostlikelylistedeffectofchannel
stuffing.Answer(b)iscorrectbecause
channelstuffingisamarketingpracticethat
supplierssometimesusetoboostsalesby
inducingdistributorstobuysubstantially
moreinventorythantheycanpromptly
resell;accordingly,increasedsalesreturns
inthefuturearelikely.Answers(a),(c)and
(d)areincorrectbecauseaccrued
liabilities,cash,andmarketable
investmentsarelesslikelytobeaffectedby
channelstuffing,whichresultsinentries
increasingaccountsreceivable,costof
goodsold,andsales,whiledecreasing
inventory.
C.11.Expenses
120.(d)Therequirementistoidentifythe
accountinwhicharecordedentryismost
likelytorelatetotheproperty,plant,and
equipmentcompletenessassertion.The
completenessassertionaddresseswhether
alltransactionshavebeenrecordedinan
account(here,property,plant,and
equipment).Answer(d)iscorrectbecause
thepurchaseofproperty,plant,and
equipmentmayinappropriatelyhavebeen
recordedintherepairsandmaintenance
accountratherthaninproperty,plant,and
equipment;thisisafrequentbookkeeping
errorsincetheindividualrecordingthe
entrymayfrequentlyseesimilarinvoices
whichdorepresentrepairsand
maintenanceexpense.Answers(a),(b),
and(c)areallincorrectbecausethe
allowancefordoubtfulaccounts,
marketablesecurities,andsaleshasno
apparentrelationshiptothecompleteness
ofrecordingofproperty,plant,and
equipment.
C.12.ClientRepresentationLetters
121. (c)Therequirementistoidentify
thematteronwhichanauditor
shouldobtainwritten
managementrepresentations.
Answer(c)iscorrectbecause
writtenrepresentationsare
ordinarilyobtainedon
noncompliancewithaspectsof
contractualagreementsthatmay
affectthefinancialstatements.
Answer(a)isincorrectbecause
auditorsdonotordinarilyobtain
acostbenefitjustificationfrom
managementrelatedtointernal
controlweaknesses.Answer(b)
isincorrectbecausewritten
representationsarenotordinarily
obtainedonsuchfutureplans.
Answer(d)isincorrectbecause
managementmayormaynotbe
responsibleforemployee
violationsoflaws,andbecause
sucharepresentationisnot
ordinarilyobtained.SeeAU333
forinformationonclient
representations.
122. (a)Therequirementistodetermine
amattertowhichmaterialitylimits
donotapplyinobtainingwritten
managementrepresentations.
Answer(a)iscorrectbecause
materialityconsiderationsdonot
applytomanagements
acknowledgmentofits
responsibilityforfairpresentation
offinancialstatements,the
availabilityofallfinancialrecords,
thecompletenessandavailability
ofallminutesandmeetingsof
stockholders,directors,and
committeesofdirectors,and
communicationfromregulatory
agencies.Answers(b),(c),and(d)
areallincorrectbecause
materialityconsiderationsrelateto
lossesfrompurchase
commitments,compen
MODULE4RESPONDINGTORISKASSESSMENT
satingbalances,andobsoleteinventory.
AU333discussesclientrepresentations.
123. (c)Therequirementisto
determinetheproperdatefora
clientsrepresentationletter.AU
333statesthattherepresentation
lettershouldbedatedasofthe
dateoftheauditorsreport.
124. (b)Therequirementistoidentifythe
matterthatanauditormostlikelywould
includeinamanagementrepresentation
letter.Auditorswillgenerallyrequest
assuranceastothecompletenessand
availabilityofminutesofstockholders
anddirectorsmeetings.SeeAU333for
writtenrepresentationsordinarilyobtained
bytheauditor.
125. (d)Therequirementisto
determinetheyear(s)onwhicha
CPAmustobtainwritten
representationsfromman
agement,whencomparative
financialstatementsarebeing
issued,butcurrentmanagement
hasonlybeenemployedfora
portionofoneofthoseyears.AU
333statesthatifcurrent
managementwasnotpresent
duringallperiodsreportedupon,
theauditorshouldnevertheless
obtainwrittenrepresentations
fromcurrentmanagementonall
suchperiods.
126. (a)Therequirementistoidentify
theinformationordinarilyincluded
amongthewrittenclient
representationsobtainedbythe
auditor.Answer(a)iscorrect
because
AU333includesinformationon
compensatingbalancesinthelistof
representationsnormallyobtained.Answer
(b)isincorrectbecausemanagementneed
notacknowledgearesponsibilityfor
employeeillegalactions.Answer(c)isin
correctbecausetheauditor,nottheclient,
determineswhethersufficientaudit
evidencehasbeenmadeavailable.Answer
(d)isincorrectbecause,forpurposesofa
financialstatementaudit,management
neednotattempttodeterminewhether
materialweaknessesininternalcontrol
exist.
127. (a)Therequirementisto
determinethecorrectstatement
withrespecttotheuseofa
managementrepresentation
letterasauditevidenceaboutthe
completenessassertion.Answer
(a)iscorrectbecausesuch
writtenrepresentationsare
151
meanttocomplement,butnot
replace,substantivetests.
Answer(b)isincorrectbecause
thecomple
mentarynatureofsuchrepresentationsisnot
consideredsufficient,evenwhencombined
withrelianceuponinternalcontrol.The
inherentlimitationsofinternalcontroldonot
permittheauditortoreplacesubstantivetests
withcompleterelianceoninternalcontrol.
Answer(c)isincorrectbecausethewritten
representationsareconsideredcomplementary
evidenceinsupportofvariousassertions.
Answer(d)isincorrectbecausesuchwritten
representationsarenotconsideredtobe
replacementsforrelianceuponinternal
control.
128. (a)Therequirementisto
determinewhoshouldsigna
letterofrepresentation.AU333
statesthat,normally,thechief
executiveofficerandthechief
financialofficersshouldsignthe
letterofrepresentation.
129. (d)Therequirementistoidentify
thescopelimitationwhichinall
casesissufficienttoprecludean
unqualifiedopinion.Answer(d)
iscorrectbecausetheprofessional
standardsstatethatmanagement
refusaltofurnishwritten
representationsconstitutesa
limitationonthescopeofthe
auditorsexaminationsufficient
toprecludeanunqualified
opinion.Answer(a)isincorrect
becausemanagementsrefusalto
allowtheauditortoreviewthe
predecessorsworkmaynot
necessarilyresultinreport
modification.An
swer(b)isincorrectbecausealternate
proceduresmaybeavailablethatwillmake
reportmodificationunnecessarywhenthe
auditorhasbeenengagedaftercompletion
oftheyearendphysicalcount.Answer(c)
isincorrectbecausemanagementmay
choosenottocorrectasignificant
deficienciesininternalcontrolwithouta
resultinglimitationonthescopeofthe
audit.
130. (c)Therequirementistoidentifyapurpose
ofamanagementrepresentationletter.
Answer(c)iscorrectbecausea
managementrepresentationletterismeant
toreducethepossibilityofa
misunderstandingconcerning
managementsresponsibilityforthe
financialstatements.Answer(a)is
incorrectbecausereducingauditrisktoan
aggregatelevelofmisstatementthatcould
beconsideredmaterialisnotalogically
soundstatement.Answer(b)isincorrect
becausethemanagementrepresentation
letterdoesnotmodifyanauditors
responsibilitytodetectmaterialmis
statements.Answer(d)isincorrectbecause
managementrepresentationlettersarenota
substituteforotherprocedures.
131. (c)Therequirementistoidentify
themostlikelysourceofa
statementsuggestingthatthere
havebeennocommunications
fromregulatoryagencies.
Answer(c)iscorrectbecause
informationsuchasthisis
ordinarilyincludedina
managementrepresentation
letter.Answers(a),(b),and(d)
areincorrectbecausesucha
disclosureisnotordinarily
includedinareportoninternal
control,aspecialreport,ora
letterforanunderwriter.SeeAU
333forguidanceon
representationletters.
C.13.UsingtheWorkofaSpecialist
132. (a)Therequirementistoidentifythe
correctstatementconcerninganauditors
useoftheworkofaspecialist.Answer(a)
iscorrectbecausetheworkofaspecialist
whoisrelatedtotheclientmaybe
acceptableundercertaincircumstances.
Answer(b)isincorrectbecauseifthe
auditorbelievesthatthefindingsofthe
specialistareunreasonable,itisgenerally
appropriatetoobtainthefindingsof
anotherspecialist.Answer(c)isincorrect
becauseamaterialdifferencebetweena
specialistsfindingsandthoseincludedin
thefinancialstatementsmayresultinthe
needforanexplanatoryparagraph,a
qualifiedopinion,adisclaimer,oran
adverseopinion.Answer(d)isincorrect
becauseanauditormayuseaspecialistin
thedeterminationofvariousphysical
characteristicsofassets.
133. (a)Therequirementistoidentify
acircumstanceinwhichan
auditormayrefertothefindings
ofaspecialistintheauditors
report.Answer(a)iscorrect
becausetheauditormayreferto
thespecialistwhenthe
specialistsfindingsresultin
inclusionofanexplanatory
paragraphtoanauditreport,in
thiscaseongoingconcernstatus.
Answers(b),(c),and(d)areall
incorrectbecauseaspecialistis
onlyreferredtoinanauditreport
whenthatspecialistsfindings
identifyacircumstancerequiring
modificationoftheauditreport.
Auditorsdonotmodifyaudit
reportstosimplyinformtheuser
thataspecialistwasinvolved.
134. (d)Therequirementistoidentify
thestatementthatiscorrectabout
theauditorsuseoftheworkofa
specialist.Answer(d)iscorrect
becausetheauditorshouldobtain
anunderstandingofthenatureof
theworkperformedbythe
specialist.Answer(a)isincorrect
becauseordinarilyaspecialist
willhaveabasicunderstanding
oftheauditorscor
152
MODULE4RESPONDINGTORISKASSESSMENT
report.
roborativeuseofthefindings.Answer(b)is
incorrectbecausetheauditorneednot
performsubstantiveprocedurestoverifythe
specialistsassumptionsandfindings.Answer
(c)isincorrectbecausetheclientmayhavean
understandingofthenatureofthework
performedbythespecialist.See
AU336(revisedin1994bySAS73)for
informationontheauditorsuseofthe
workofaspecialist.
135. (b)Therequirementisto
identifythecircumstancein
whichanauditormay
appropriatelyrefertothe
findingsofaspecialist.Answer
(b)iscorrectbecauseanauditor
mayrefertoaspecialistwhen
thereportisbeingmodifieddue
tothespecialistsfindings.
Answers(a)and(c)are
incorrectbecauseaclients
familiaritywithaspecialistor
understandingoftheauditors
useofthefindingsofaspe
cialistdoesnotresultin
modificationoftheauditreport.
Answer(d)isincorrectbecause
anauditordoesnotdivide
responsibilitywithaspecialist.
136. (c)Therequirementistoidentify
thestatementthatanauditormust
documentwhenusingthework
ofaspecialist.Answer(c)is
correctbecausethespecialists
understandingoftheauditors
corroborativeuseofhisorher
findingsmustbedocumented.
SeeAU336forthisandother
documentationrequirements.
Answer(a)isincorrectbecause
nostatementconcerningan
updateofthespecialistsreport
isrequiredtobedocumented.
Answer(b)isincorrectbecausea
divisionofresponsibilityrelates
tocircumstancesinwhichother
auditors,notspecialists,arein
volved.Answer(d)isincorrect
becauseanauditorwillnot
normallyissueadisclaimer
relatedtowhetherthespecial
istsfindingscorroboratethe
representationsinthefinancial
statements.Thespecialists
reportisonlyreferredtowhen
thereisamaterialdifference
betweenthespecialistsfindings
andtherepresentationsinthe
financialstatements.SeeAU336
forinformationontheeffectofa
specialistsworkonanauditors
137. (c)Therequirementisto
determinewhichindividualis
notconsideredaspecialistupon
whoseworkanindependent
auditormayrely.The
professionalstandardsrelatingto
usingtheworkofaspecialistdo
notapplytousingtheworkofan
internalauditor.Answers(a),(b),
and(d),actuary,appraiser,and
engineer,respectively,areall
examplesofspecialistsperthe
professionalstandards.Notehere
thatthequestionanditsreplydo
notimplythataCPAcannotuse
theworkofaninternalauditor.
Whatisbeingsuggestedisthat
aninternalauditorisnot
consideredaspecialistunderthe
professionalstandards.
C.14.InquiryofaClientsLawyer
138.(d)Therequirementistoidentify
whichpartiesshouldreachanunderstanding
onthelimitsofmaterialityforpurposesofa
lawyersresponsetoanauditorsinquiry
concerninglitigation,claims,and
assessments.Answer(d)iscorrectbecause
AU337statesthatalawyersresponseto
aninquirymaybelimitedtomaterialitems,
providedthelawyerandtheauditorhave
reachedanunderstandingonthelimitsof
materialityforthispurpose.Answer(a)is
incorrectbecauseitincludestheclients
management.An
swer(b)isincorrectbecauseitincludes
the clients audit committee and omits
the auditor. Answer (c) is incorrect
because it includes the clients
managementandomitstheauditor.
139. (b)Therequirementistoidentify
thecorrectstatementconcerning
therefusalofaclientsattorneyto
provideinformationrequestedin
aninquiryletter.Answer(b)is
correctbecauseAU337indicates
thatthisisalimitationonthe
scopeoftheaudit.Answer(a)is
incorrectbecausethelackof
informationisunlikelytoleadto
anadverseopinionsinceno
informationhasbeenprovided
indicatingthatthefinancial
statementsaremisstated.Answer
(c)isincorrectbecausewithdrawal
isnotgenerallynecessarydueto
theclientsattorneysfailureto
provideinformation.An
theclientsattorneyisthe
auditorsprimarymeansof
obtainingcorroborationofthe
informationfurnishedby
managementconcerning
litigation,claims,and
assessments.Answer(a)is
incorrectbecauseitwilloftenbe
impossibletodeterminethe
probableoutcomeofasserted
claimsandpendingorthreatened
litigation.Answer(c)isincorrect
becausenosuchopinionson
historicalexperiencesare
generallyavailable.Answer(d)is
incorrectbecausethedescription
oflitigation,claims,and
assessmentsisgenerallyprepared
bytheclient.
142. (b)Therequirementistoidentify
theprocedurethatisnotperformed
regardinglitigation,claims,and
assessments.Answer(b)iscorrect
becausetheCPAdoesnotconfirm
directlywiththeclientslawyer
thatallclaimshavebeenrecorded
inthefinancialstatements.
Answers(a),(c),and(d)areall
incorrectbecausetheyrepresent
informationobtainedfrom
managementregardinglitigation,
claims,andassessmentsas
summarizedinAU337.
143. (a)Therequirementistoidentify
theappropriatelimitationforan
attorneysresponsetoaclients
letterofauditinquiry.Answer(a)is
correctbecauseAU337statesthat
anattorneymayappropriatelylimit
hisresponsetomatterstowhich
s/hehasgivensubstantiveattention
intheformoflegalconsultationor
representation.Answers(b),(c),
and(d)areincorrectbecauseAU
337presentsavarietyofother
requestsinadditiontoinformation
onthelikelihoodofanunfavorable
outcomeofthemattersdisclosedby
theentity,similarlitigation,and
probableoutcomes.
MODULE4RESPONDINGTORISKASSESSMENT
1.
2.
(a)Ifaclientslawyerresigned
shortlyafterthereceiptofan
attorneysletterwhichindicated
nosignificantdisagreementswith
theclientsassessmentof
contingentliabilities,theauditor
shouldinquirewhytheattorney
resigned.Theauditorsconcern
iswhetheranyundisclosed
unassertedclaimshavearisen.Per
AU337,alawyermaybe
requiredtoresignifhisadvice
concerningreportingfor
litigation,claims,and
assessmentsisdisregardedbythe
client.Accordingly,the
resignationshortlyafterissuance
ofanattorneyslettermay
indicateaproblem.Answer(b)is
incorrectbecausetheattorney
issuedaletterindicatingno
significantdisagreementwiththe
clientsassessmentofcontingent
liabilities.Answers(c)and(d)are
incorrectbecauseAU337only
suggeststhattheauditorshould
considertheneedforinquiries
(i.e.,AU337doesnotrequirea
completenewexamof
contingentliabilitiesoran
adverseopinion).
(b)Therequirementistoidentify
thelawyerslettercommentthat
ismostlikelytocausetheauditor
torequestclarification.Answer
(b)iscorrectbecauseastatement
thattheactioncanbesettledfor
lessthanthedamagesclaimedis
unclearastothedetailsofthe
attorneysbelief.An
swers(a),(c),and(d)areallincorrectbecause
theyrepresentresponsesthatmaybeclearly
interpretedbytheauditor.SeeAU337,
interpretation7,forinformationonassessing
lawyersevaluationsofthelikelyoutcomeof
litigation.
C.15.FairValues
146. (a)Therequirementisto
determinewhethervaluation
issuesariseatinitialrecording,
subsequenttoinitialrecording,or
atbothtimeswhenconsidering
fairvalueofanassetorliability.
Answer(a)iscorrectbecauseAU
328makesclearthatvaluation
issuesariseatbothtimes.An
swers(b),(c),and(d)areall
incorrectbecausetheysuggest
thattherearenovaluationissues
atoneorbothofthesetime
periods.
153
147. (b)Therequirementistoidentifytheleast
likelyapproachforauditingthefairvalues
ofassetsandliabilities.Answer(b)is
correctbecauseitisdoubtfulthataudit
committeememberswillhaveinformation
onthevaluation.Answers(a),(c),and(d)
areallincorrectbecausetheyrepresentthe
threeapproachespresentedforauditingfair
values(aswellasotherestimates).
C.16.RelatedPartyTransactions
148. (c)Therequirementistoidentifythe
auditingprocedurethatwouldmostlikely
assistanauditorinidentifyingrelatedparty
transactions.Answer(c)iscorrectbecause
reviewingconfirmationsofloansreceivable
andpayableforindicationsofguarantees
mayrevealunusualtransactionsthat
involverelatedparties.SeeAU334for
proceduresrelatedtoidentifying
transactionswithrelatedparties.Answer
(a)isincorrectbecauseinspectingthe
correspondencewithlawyersforevidence
ofunreportedcontingentliabilitiesdoes
notgenerallyrelatedirectlytorelatedparty
transactions.Answer(b)isincorrect
becausenonrecurringtransactionsaremore
indicativeofrelatedpartytransactions.
Answer(d)isincorrectbecauseanalytical
proceduresperformedtoidentifypossible
financialdifficultiesdonotrelatedirectlyto
relatedpartytransactions.
149. (c)Therequirementistodeterminean
auditorsresponsibilityafterhaving
determinedthatarelatedpartytransaction
hasoccurred.Answer(c)iscorrectbecause
after
identifyingtheexistenceofsuchanact,the
auditorshouldobtainanunderstandingofthe
businesspurposeofthetransaction.SeeAU
334forthisandotherresponsibilities.An
swer(a)isincorrectbecausethemere
existenceofarelatedpartytransactionmayor
maynotleadtoauditreportmodification.
Answer(b)isincorrectbecausetheperfor
manceofanalyticalproceduresisnot
required.Answer(d)isincorrectbecause
exceptforroutinetransactions,itwill
generallynotbepossibletodetermine
whetherthetransactionwouldhavetaken
place,orwhetheritwasconsummatedon
termsequivalenttoanarmslength
transaction.
150. (d)Therequirementisto
identifythecorrectstatement
concerningrelatedparty
transactions.Answer(d)is
correctbecauseAU334requires
thattheauditorshouldplace
primaryemphasisonthe
adequacyofdisclosure.Answer
(a)isincorrectbecause
ascertainingrightsandobliga
tionsisonlypartoftheauditors
totalresponsibilityandnotthe
primaryemphasis.Answer(b)is
incorrectbecausewhileauditors
attempttodeterminethe
existenceofrelatedparties,this
isnottheprimaryemphasis.
Answer(c)isincorrectbecause
verifyingthevaluationof
relatedpartytransactionswill
oftennotbepossible.
151. (d)Therequirementistoidentify
thecorrectstatementconcerning
relatedpartytransactions.
Answer(d)iscorrectbecauseAU
334requiresthatprocedures
directedtowardidentifying
relatedpartytransactionsshould
beperformed,eveniftheauditor
hasnoreasontosuspecttheir
existence.Answer(a)isincorrect
because,intheabsenceof
evidencetothecontrary,related
partytransactionsneednotbe
assumedtobeoutsidethe
ordinarycourseofbusiness.
Answer(b)isincorrectbecause
theauditorwillnotingeneralbe
abletodeterminewhethera
particulartransactionwouldhave
occurredifthepartieshadnot
beenrelated.Answer(c)is
incorrectbecause,ifproper
disclosuresaremade,therelated
partytransactionsarenotrequired
toberecordedonterms
equivalenttoarmslength
transactions.
152. (c)Therequirementistoidentify
thecircumstanceinwhichan
auditormostlikelywouldmodify
anunqualifiedopinionifthe
entitysfinancialstatements
includeafootnoteonrelated
partytransactions.Answer(c)is
correctbecauseitgenerallywill
notbepossibletodetermine
whetheraparticulartransaction
wasconsummatedonterms
equivalenttothosewithunrelated
parties.Therefore,theauditor
mayberequiredtoexpressa
qualifiedoranadverseopinion
whensuchanunsubstantiated
disclosureisincluded.Answers
(a),(b),and(d)areallincorrect
becausetheyrepresentsituations
thatmaybedisclosedinrelated
partytransactiondisclosures.
C.17.SubsequentEvents
153.(d)Therequirementistoidentifythe
mostlikelyproceduretobeperformedin
obtainingevidenceaboutsubsequent
events.Answer(d)iscorrectbecause
changesinlongtermdebtoccurringafter
yearendmayrequirenotedisclosure.
Answers(a)and(b)areincorrectbecause
auditorswillnotgenerallytestchangesin
employeepayratesafteryearendor
recomputedepreciationexpenseforplant
assetssold.Answer(c)isincorrect
becausepayrollchecksissuednearyear
endmayfrequentlybecashedafteryear
endandtheirinvestigationwillnotin
generalbedirectlyrelatedtoobtaining
evidenceaboutsubsequentevents.See
AU560fortheresponsibilitiesofauditors
withrespecttosubsequentevents.
154
MODULE4RESPONDINGTORISKASSESSMENT
completionoftheauditorsfieldwork.
Answer(c)iscorrectbecausethe
transactiondescribedisatype2subsequent
event(sincetheacquisitionprovided
evidenceofaconditionwhichcameinto
existenceafteryearend)andthereforethe
properaccountingapproachwouldbenote
disclosureratherthanadjustment.Answer
(a)isincorrectbecauseadjustmentsare
onlyappropriatefortype1subsequent
events(eventswhichprovideevidencethat
theconditionwasinexistenceatyearend).
Answer(b)isincorrectbecausetheauditor
doesnotissuefinancialstatementsforthe
client.Answer(d)isincorrectbecausethe
opinionparagraphofthereportneednotbe
modified;ifanyreportmodificationwere
considerednecessary,itwouldbean
explanatoryparagraphemphasizingthe
matter.
154. (c)Therequirementistoidentifytheevent
occurringaftertheissuanceofanauditors
reportthatwouldmostlikelycausethe
auditortomakefurtherinquiriesaboutthe
previouslyissuedfinancialstatements.
Answer(c)iscorrectbecausewhenan
auditorbecomesawareofinformation
whichrelatestothefinancialstatements
previouslyreportedupon,butwhichwas
notknownatthedateofthereport,heor
sheshouldundertaketodeterminewhether
theinformationisreliableandwhetherthe
factsexistedatthedateoftheauditreport;
inthiscircumstanceitseemsthatthelease
transactionsexistedasofthedateofthe
auditreport.Answer(a)isincorrect
becausethenaturaldisasteroccurred
subsequenttotheissuanceoftheaudit
report.Answer(b)isincorrectbecausethe
contingencyhadbeenproperlydisclosed. 158. (d)Therequirementistoidentifya
procedurethatanauditorwouldperformto
Answer(d)isincorrectbecausethesaleof
obtainevidenceabouttheoccurrenceof
thesubsidiaryoccurredsubsequenttothe
subsequentevents.Answer(d)iscorrect
issuanceoftheauditreport.
becauseanauditorwillinquireofofficers
andotherexecutiveshavingresponsibility
155. (d)Therequirementisto
forfinancialandaccountingmatters
determineproperaccountingand
whetheranyunusualadjustmentshavebeen
auditingtreatmentof
madeduringtheperiodfromthebalance
uncollectibilityofanaccount
sheetdatetothedateofinquiry.SeeAU
receivableresultingfroma
560forauditingproceduresperformedto
customersbankruptcyduetoa
identifysubsequentevents.
naturaldisasteroccurringaftera
clientsbalancesheetdate.
Answer(d)iscorrectbecausea
customersmajorcasualtyloss
afteryearendwillresultina
financialstatementnote
disclosurewithnoadjustmentand
noauditreportmodificationdue
toconsistency.
156. (d)Therequirementisto
determineanauditors
responsibilitywhensubsequentto
issuanceofanauditreporta
clientsellsthesharesofamajor
subsidiary.Answer(d)iscorrect
becausenoactionneedbetaken
sincetheeventaroseafterthe
issuanceoftheauditorsreport.
Answers(a),(b),and(c)areall
incorrectbecausetheyoutline
responsibilitieswhicharenot
appropriateinthiscircumstance.
SeeAU561foradiscussionof
auditorresponsibilitywhen
subsequenttotheissuanceofthe
auditorsreporttheauditor
becomesawareofafactthat
existedatthedateofthe
auditorsreport.
157. (c)Therequirementistodeterminethe
auditorsresponsibilitywithrespecttoa
clientacquisitionof25%ofitsoutstanding
capitalstockafteryearendandpriortothe
159.(a)Therequirementistodeterminea
procedurethatanauditorshouldgenerally
performregardingsubsequentevents.
Answer(a)iscorrectbecausethe
ProfessionalStandardsstatethattheauditor
generallyshouldcomparethelatest
availableinterimfinancialstatementswith
thefinancialstatementsbeingaudited.See
AU560forthisandotherrequirements.
Answer(b)isincorrectbecausesecond
accountsreceivableconfirmationrequests
willbesentwellbeforetheauditors
reviewofsubsequentevents.An
swer(c)isincorrectbecausethe
communicationofmaterialweaknessesisnot
asubsequenteventprocedure.See
AU325fortherequiredcommunication
of significantdeficiencies. Answer (d)
is incorrect because auditorsgenerally
only receive cutoff statements for the
periodimmediatelyafteryearend,not
formultiplemonths.
C.18.OmittedProceduresDiscovered
AftertheReport
Date
160. (b)Therequirementistoidentify
anauditorsresponsibilitywhena
clientrefusestoadjustrecently
issuedfinancialstatementsfora
subsequenteventrelatedtothe
bankruptcyoftheentitysprincipal
customer.Answer(b)iscorrect
becauseiftheclientrefusestomake
disclosures,AU
561 requirestheauditortonotifyeach
memberoftheboardofdirectors
ofsuchrefusalandthatheorshe
willtakestepstopreventfuture
relianceupontheauditreport.
Ordinarilytheauditorwillthen
notifytheclientsandregulatory
agenciesthatthereportshould
nolongerbeassociatedwiththe
financialstatements,andwhen
possible,notifypersonsknownto
berelyinguponthefinancial
statements.Answer(a)is
incorrectbecauseitislesslikely
thatallofthecreditorswillbe
informed.Answer(c)isincorrect
becausethefinancialstatements
aretheresponsibilityofmanage
ment,andtheauditorwillnot
reviseordistributethem.Answer
(d)isincorrectbecauseno
revisedreportwillbeissued.
161. (c)Therequirementistoidentifythe
circumstanceinwhichanauditorwhofinds
thatheorshehasomittedasubstantive
procedureatthetimeofanauditmay
decidenottoapplythatprocedure.Answer
(c)iscorrectbecausewhenresultsofother
procedurestendtocompensateforthepro
cedureitmaybeomitted.Answer(a)is
incorrectbecause,evenwhendistribution
ofthefinancialstatementhasbeenlimited
tomanagementandtheboardofdirectors,
itmaybenecessarytoperformthe
procedure.Answer(b)isincorrectbecause
thetypeofreportissueddoesnotaffectthe
needtoperformtheprocedure.Answer(d)
isincorrectbecausedelaysbytheclientin
providingdataarenotanacceptablereason
nottoperformthatprocedure.
162. (b)Therequirementisto
determineprofessional
responsibilitywhen,subsequent
toissuanceofanauditreport,an
auditorhasdeterminedthata
necessaryauditprocedurehas
beenomitted.Answer(b)is
correctbecauseanauditormust
applyproceduresthatwould
provideasatisfactorybasisfor
theopinionissued.Answer(a)is
incorrectbecausestockholders
neednotbeinformedatthispoint
thattheauditreportshouldnotbe
reliedupon.Answer(c)is
incorrectbecausetheauditors
reportwillnotbereissuedunless
thefinancialstatementsare
restated.Answer(d)isincorrect
becausetestsofcontrolswillnot
compensatefortheomitted
procedure.SeeAU390for
overallproceduresrelatingto
consideringomittedprocedures
afteranauditreporthasbeen
issued.
MODULE4RESPONDINGTORISKASSESSMENT
163.(c)Therequirementistoidentifyan
auditorsfirstresponsibilityupon
discoveringsixmonthsaftercompletionof
anauditthatengagementpersonnelfailed
toconfirmseveraloftheclientsmaterial
accountsreceivablebalances.Answer(c)is
correctbecausetheauditormustfirst
assesstheimportanceoftheomitted
procedurestotheauditorsabilityto
supportthepreviouslyexpressedopinion.
Answers(a)and(b)areincorrectbecause
priortoattemptinganysuchconfirmation
orperformingalternativeprocedures,an
assessmentofwhethertheproceduresare
neededistobeperformed.Answer(d)is
incorrectbecauseaconsiderationof
whetheranyoneisrelyingon,orislikelyto
relyon,theunqualifiedopinionismade
afterassessingtheimportanceofthe
omittedprocedure.
D. CompletingtheAudit
164. (c)Therequirementisto
determinetheprocedureleast
likelytobeperformedbeforethe
balancesheetdate.Answer(c)is
correctbecausethesearchfor
unrecordedliabilitiesrelies
uponareviewofdocuments
unrecordedatyearend,aswell
asinspectionofpurchasesand
disbursementsrecordedafter
yearend,todeterminewhethera
propercutoffoftransactions
betweenperiodshasoccurred.
Answer(a)isincorrectbecause
auditorsareabletotestinternal
controlovercashpriortoyear
end.Answers(b)and(d)are
incorrectbecauseincasesof
goodinternalcontrol,
receivablesmaybeconfirmed
andinventoryobservedpriorto
yearend.
165. (c)Therequirementisto
determinethemostlikelytypeof
transactionthatwouldbe
detectedbyanauditorsreview
ofaclientssalescutoff.Answer
(c)iscorrectbecausethe
auditorsreviewwillincludea
studyofsalesrecordedlatein
DecemberandearlyinJanuary.
Thiswillbeaccomplishedby
reviewingtheperiodwhenthe
revenuewasearnedbyshipment
ofgoodsorperformanceofser
vices,ascomparedtotheperiod
inwhichtherevenuewas
recorded.Accordingly,the
reviewofsalesrecordedin
Januarymayrevealunrecorded
salesfortheprecedingyear.
155
Answer(a)isincorrectbecause
shipmentslackingsalesinvoices
andshippingdocumentswillbe
verydifficulttoidentify;also,
thisreplyismorelimitedthan
answer(c).Answer(b)is
incorrectbecauseexcessive
writeoffsofaccountsreceivable
willnotusuallybedetectedwhen
testingthesalescutoff.Answer
(d)isincorrectbecauseitis
unlikelythatlappinginthe
applicationofcashreceiptswill
bedetectedbysalescutoff
testing.Morefrequently,proce
duressuchasconfirmations,
analyticalprocedures,andan
analysisofdepositticketsreveal
lapping.
166. (b)Therequirementistoidentifythe
assertionbeingtestedbycutofftests
designedtodetectcreditsalesmadebefore
theendoftheyearthathaveimproperly
beenrecordedinthesubsequentyear.
Answer(b)iscorrectbecausethe
completenessassertiondealswithwhether
alltransactionshavebeenincludedinthe
properperiod.Answer(a)isincorrect
becausethepresentationordisclosure
assertiondealswithwhetherparticular
componentsofthefinancialstatementsare
properlyclassified,described,and
disclosed.Answer(c)isincorrectbecause
therightsandobligationsassertiondeals
withwhetherassetsaretherightsofthe
entityandliabilitiesaretheobligationsof
theentityatagivendate.Answer(d)is
incorrectbecausetheexistenceor
occurrenceassertiondealswithwhether
assetsorliabilitiesoftheentityexistata
givendateandwhetherrecorded
transactionshaveoccurredduringa
givenperiod.Inthisquestion,the
existenceassertionwouldbetestedif
theauditorsampledfromsalesrecorded
priortoyearendtodeterminewhether
thesaleoccurredbeforeorafteryear
end.
D.1.ProceduresCompletednearthe
EndoftheAudit
167.(d)Therequirementistoidentifythe
procedureanauditorwouldmostlikely
performduringtheoverallreviewstageof
formulatinganopiniononanentitys
financialstatements.Answer(d)iscorrect
becauseaconsiderationofresultsrelating
totheassessmentoftheriskofmaterial
misstatementduetofraudmayrevealthat
theaudithasinadequatelyaddressedthat
risk;insuchacaseadditionalprocedures
wouldberequired.Answer(a)isincorrect
becausesuchassurancefromtheentitys
attorneyisordinarilyobtainedpriortothe
overallreviewstageofanaudit.Answer
(b)isincorrectbecausetheverificationof
theaccuracyoftheproofofcashis
ordinarilyperformedpriortotheoverall
reviewandbecauselittleverificationofthe
bankcutoffstatementisusuallynecessary
sinceitisordinarilyreceiveddirectlyby
theauditorfromthebank.Answer(c)is
incorrectbecausesuchprovisionsforthe
safeguardingofassetsmaybecorrected
wellaftertheconclusionoftheaudit.
F.OperationalAuditing
168. (a)Therequirementistoidentifythe
correctstatementwithrespecttothe
primaryorientationofoperationalauditing.
Answer(a)iscorrectbecauseoperational
auditsdealprimarilywithevaluatingthe
efficiencyandeffectivenesswithwhich
operationsfunction,oftenwiththe
intentionofmakingimprovementsto
accomplishthegoalsofmanagement.
Answers(b)and(c)areincorrectbecause
financialstatementauditsareoriented
towardsuchdeterminations,not
operationalaudits.Answer(d)isincorrect
becauseexaminationsofinternalcontrol
arenotperformedonoperationalaudits.
169. (d)Therequirementistoidentifyatypical
objectiveofanoperationalaudit.Answer
(d)iscorrectbecauseoperationalaudits
typicallyaddressefficiencyandeffective
ness.Answer(a)isincorrectbecausewhile
theadequacyofinternalcontroldesignmay
beaddressedduringanoperationalaudit,
thisislesscompletethananswer(d).An
swer(b)isincorrectbecauseoperational
auditsmayormaynotberelatedto
compliancewithgenerallyacceptedgov
ernmentalauditingstandards.Answer(c)
isincorrectbecausefinancialstatement
audits,notoperationalaudits,address
whetherresultsofoperationsarefairly
presented.
156
MODULE4
RESPONDINGTORISKASSESSMENT
Authoritative
Literature
Help
SOLUTIONSTOSIMULATIONS
TaskBasedSimulation1
AuditInvestmentsand
AccountsReceivable
1.
A
u
I
2.
3.
T
E
1.
(E)Theverificationoftransfersfromthecurrenttothenoncurrentinvestmentportfoliowill
provideassurancethattheinvestmentsareproperlyclassifiedinthefinancialstatements.
4.
A
u
A
5.
6.
7.
A
E
2.
(F)Positiveconfirmationrepliesasofthebalancesheetdateforinvestmentsheldby
independentcustodianswillprovideassurancethattherecordedinvestmentsarein
factownedbytheauditclient.
3.
7.
4.
(B) Performance of sales cutoff tests will provide assurance that sales
transactionsandtherelatedreceivablesarerecordedintheproperperiod.Thus,
salescutofftestswillprovideassurancethatallamountsowedtotheentityatthe
balancesheetdatearerecordedinthatperiod.
5.
(E)Areviewofloanagreements,payingspecialattentiontoaccountsreceivable
thathavebeenfactored,willprovideassuranceastowhethertheentityhasalegal
righttoallaccountsreceivableatthebalancesheetdate.
6.
(C) An analysis of the aged trial balance for significant past due accounts will
provideevidencewithrespecttoaccountsthatmaybeuncollectible.Accordingly,
theprocedurewilladdressthenetrealizablevalueofaccountsreceivable.
(F)Becausematerialamountsduefromofficersandemployeesshouldbesegregatedfromother
receivables,areviewofthetrialbalanceforamountsduefromofficersandemployeeswill
provideassurancethataccountsreceivableareproperlydescribedandpresentedinthefinancial
statements.
T
R
e
A
u
L
i
1.
2.
W
h
E
MODULE4RESPONDINGTORISKASSESSMENT
TaskBased
Simulation3
IllegalActsand
Related
Party
Transactions
Authoritati
ve
Literature
Help
157
IA
RP
Statement
1.
Anotepayablehasaninterestratewellbelowthemarketrateatthetimeatwhichthe
loanwasobtained.
2.
Thecompanyhasaproperlydocumentedloanbuttheloanhasnoscheduledrepayment
terms.
3.
Unexplainedpaymentshavebeenmadetogovernmentofficials.
4.
Thecompanyexchangedcertainrealestatepropertyforsimilarrealestateproperty.
5.
Largecashreceiptsnearyearendhavebeenreceivedbasedoncashsalesforwhich
thereisnodocumentation.
TaskBasedSimulation4
AccountsReceivable
Confirmations
4.
S
t
T
h
A
S
e
C
5.
6.
A
b
A
u
A
1.
2.
3.
7.
8.
9.
T
h
10. A
c
T
A
Iu
n
L
i
Authoritative
Literature
Help
S
t
1.
W
i
2.
W
h
A
3.
4.
A
u
158
5.
6.
S
t
W
h
I
7.
I
n
8.
9.
10. A
t
MODULE4RESPONDINGTORISKASSESSMENT
TaskBasedSimulation6
Research
Authoritative
Literature
Help
1.
Authoritative
Literature
Help
(D, I) The balance per bank may be traced to a standard form used to confirm
accountbalanceinformationwithfinancialinstitutionsandtothecutoffstatement
(onwhichwillappearthebeginningbalance).
2.
(A, G, H, I, J) One of the deposits in transit does not appear onthe cutoff bank
statement(the9/29/05depositfor
$4,500).Accordingly,thatdepositshouldbetracedtothecashreceiptsjournal(procedureA),
thereasonforthedelayshouldbeinvestigated(procedureG),andsupportingdocuments
shouldbeinspected(procedureH).Bothdepositsshouldbetracedtoandfromthebank
reconciliationandthecutoffstatement(proceduresIandJ).
3.
4.
(E)Thecreditmemofromthebankforthenotecollectedshouldbeinvestigated.
5.
6.
(B,G,H,I,J)Oneofthechecksdoesnotappearonthecutoffstatement(check
#988dated8/31/05for$2,200).Accordingly,thatcheckshouldbetracedtothe
cashdisbursementsjournal(procedureB),thereasonforthedelayshouldbein
vestigated(procedureG),andsupportingdocumentsshouldbeinspected
(procedureH).Allchecksshouldbetracedtoandfromthebankreconciliation
andcutoffstatement(proceduresIandJ).
(E,I)Thecreditforthecheckthat was charged bythebankforanincorrect
amountshouldbeinvestigatedonboththebankcreditmemoandonthecutoff
statement.
(C)Theonlysourceofthebalanceperbooksisthecashgeneralledgeraccountasof
9/30/05.
TaskBasedSimulation8
Audit
Procedures
Authoritative
Literature
Help
1.
(E)Kitinginvolvesmanipulationscausinganamountofcashtobeincludedsimultaneouslyin
thebalanceoftwoormorebankaccounts.Kitingschemesarebasedonthefloatperiodthe
timenecessaryforacheckdepositedinonebanktoclearthebankonwhichitwasdrawn.To
detectkiting,abanktransferscheduleispreparedtodeterminewhethercashisimproperly
includedintwoaccounts.
2.
(D)Acomparisonoftheclearedcheckstotheyearendbankreconciliationwillidentifychecks
332
22
thatwerenotmaileduntilafterthefirstweekofthesubsequentyearbecausemostofthose
checkswillnotbereturnedwiththecutoffstatementandwillappeartoremainoutstandingan
abnormallylongperiodoftime.
3.
(H)Amongthetermsconfirmedforsuchaborrowingarrangementwillbeinformation
onliens.
MODULE4RESPONDINGTORISKASSESSMENT
4.
(K,L)Areplytothesecondrequest,orinformationfromthecreditagency,may
confirm the existence of the new customer. Also, examination of shipping
documentswillrevealwherethegoodswereshipped,andordinarilytowhich
party.
5.
(P)Observingthepayrollcheckdistributiononasurprisebasiswillassistin
detectionsincetheauditorwillexaminedetailsrelatedtoanypaychecksnot
pickedupbyemployees.
6.
(Q)Vouchingdatainthepayrollregistertodocumentauthorizedpayrateswill
revealsituationsinwhichanemployeeisearningincomeataratethatdiffersfrom
theauthorizedrate.
7.
(A)Acomparisonofthedetailsofthecashreceiptsjournaltothedetailsonthe
dailydepositslipswillrevealacircumstancesincethedetailswillhavebeen
postedtoaccountsduringthelastweekoftheyearunderaudit.
8.
(U)Whenvouchersareprocessedformerchandisenotorderedorreceived,there
willbenosupportingpurchaseordersandreceivingreportsandthiswillalertthe
auditortotheproblem.
9.
(B)Scanningthedebitstothefixedassetaccountsandvouchingselectedamounts
willrevealrepairsthathaveimproperlybeencapitalized.
10. (A,J)Lappinginvolvesconcealingacashshortagebydelayingtherecordingof
journalentriesforcashreceipts.Sincelappingincludesdifferencesbetweenthe
detailsofpostingstothecashreceiptsjournalandcorrespondingdepositslips,com
paringtheserecordswillrevealit.Also,confirmationrequestsmayidentifylapping
whenpaymentsofreceivables(asindicatedbyconfirmationreplies)appeartohave
takentoomuchtimetobeprocessed.
11. (E)Increasingcashbydrawingacheckinthismannerisaformofkiting(see
answer 1). Preparation of a bank transfer schedule will assist the auditor in
identifyingsuchtransactions.
12. (J,L)Confirmationswillidentifyoverstatedaccountsreceivablewhencustomers
disagreewiththerecordedbalancedue.Also,therelatedoverstatedsaleswillnot
haveshippingdocumentsindicatingthatashipmenthasoccurred.
TaskBasedSimulation9
SubstantiveProceduresfor
Property,PlantandEquipment
1.
2.
5.
D
i
D
i
D
i
D
6.
3.
4.
Authoritative
Literature
Help
159
1.
(D)TherequirementistoidentifythebestsubstantiveproceduretodeterminethatDietWebhas
legalrightstothepropertyandequipmentacquiredduringtheyear.Answer(D)iscorrect
becausethedeedsandtitleinsurancecertificateswillprovideevidencethatthecompanyowns
thepropertyandequipment.
2.
(G)Therequirementistoidentifythebestsubstantiveproceduretodeterminethat
DietWebrecordedpropertyandequipmentactuallyexists.Answer(G)iscorrect
becausephysicallyexaminingtheitemswillprovidethisevidence.
3.
(B)Therequirementistoidentifyasubstantiveproceduretotestwhether
DietWebsnetpropertyandequipmentwasproperlyvaluedatthebalancesheet
date.Answer(B)iscorrectbecausereviewingdepreciationexpense(andthe
relatedallowancefordoubtfulaccounts)willindicatewhetherthenetvalueis
proper.
4.
(E)TherequirementistoidentifyhowanauditormaytestwhetherDietWeb
recordedallpropertyandequipmentassetsthatwerepurchasedduringtheyear.
Answer(E)iscorrectbecauseperformanceofacutofftestwillindicatewhether
additionsmadeduringtheyearwereproperlyrecorded.
5.
(G)TherequirementistoidentifyasubstantiveproceduretotestwhetherDietWeb
recordedallpropertyretirementsthatoccurredduringtheyear.Answer(G)is
correctbecauseexaminingthemajorrecordedpropertyandequipmentitemsmay
identifysituationsinwhichanitemhasbeenretired(oftenduetoitsreplacement)
andisnolongeravailableforphysicalexamination.
MODULE4RESPONDINGTORISKASSESSMENT
160
6.(H)TherequirementistoidentifyasubstantiveproceduretotestwhetherDietWebcapitalizedacquisitions.Answer(H)
iscorrectbecauseananalysisofrepairsandmaintenanceaccountswillrevealasituationinwhichsuchanacquisitionhas
inappropriatelybeenrecordedasanexpenseandnotcapitalized.
TaskBasedSimulation10
RiskAnalysis
Authoritative
Literature
Help
Riskidentified
1.
2.
TWDmaynothavelegaltitletocertain
property and equipment recorded as
acquiredduringtheyear.
Recordedpropertyandequipmentacquisitions
mayincludenonexistentassets.
3.
Recordednetpropertyandequipmentare
forproperamounts.
Explanationofsolutions
Relatedfinancialstatementassertion
(A)(B)(C)(D)(E)
1.
Auditprocedures
(F)(G)(H)(I)(J)(K)(L)
(C,I)Legaltitlesrelatesmostdirectlytotheclienthavingrightsovertheassets;anexaminationofdeedsandtitle
insurancecertificateswillprovideassurancethattheclienthasalegalrighttothepropertyandequipmentacquired
duringtheyear.
1.
2.
3.
D
E
1.
2.
(C)Becauseownershipinformationisincludedoninvoices,examiningvendorsinvoiceswillprovideevidencethat
thecompanylegallyownsinventoryrawmaterialitems.
(F)Selectingasampleofitemsandagreeingtothephysicalcountsheetwillestablishthatthoseitemshavebeenincludedinthe
count,andthiswilladdresscompletenessofinventories.
3.
4.
5.
6.
N
E
(C)Examiningvendorsinvoiceswillprovideevidenceastothecostoftheinventoryitems.
4.(E)WhenexaminingtheJanuary20X9salesjournaltheauditormayidentifysalesthatshouldhavebeenrecorded
inDecemberof20X8.
MODULE4RESPONDINGTORISKASSESSMENT
5.
(F)Auditorswillgenerallyinquireofthecreditmanagerastohisorherbeliefsconcerningthecollectabilityof
cariousreceivables,andtherebyobtainevidenceonthenetrealizablevalueofaccountsreceivable.Oftenonewould
expectananswersuchasanalyzeagingofreceivables.Sincethatwasnotpresenthere,(F)isthebestreply.
6.
(G) Adisclosurechecklistisusedtodeterminethatthedisclosurerequirementsofgenerallyacceptedaccounting
principleshavebeenmet.
TaskBasedSimulation12
InventoryAuditObjectives
andProcedures
1.
2.
3.
4.
D
e
D
5.
161
Authoritative
Literature
Help
1.
(A)Therequirementistoidentifyaprocedureforidentifyinginventorytransactionsinvolvingrelatedparties.Thebest
procedurelistedisreviewminutesofBoardofDirectorsmeetingandcontracts,andtomakeinquiriesofmanagement;these
areallproceduresusedtoidentifyrelatedpartytransactions.
2.
(E)Therequirementsistoidentifyaprocedurefordeterminingthatitemscountedareincludedinthecountsheet.
Thebestprocedureistoreconcilephysicalcountstoperpetualrecordsandgeneralledgerbalancesandinvestigate
significantfluctuations.Thiswillallowtheauditortoidentifyitemsnotincluded.
3.
(F)Therequirementistodeterminethatapropercutoffofpurchaseshasoccurredatyearend.Thebestprocedure
listedistoreviewsalesafteryearendandopenpurchaseordercommitmentsthiswillhelpdeterminewhether
transactionsrecordedafteryearendshouldhavebeenrecordedpriortoyearend.Anotherprocedure,notlisted,isto
performtheprocedureontransactionsrecordedrightbeforeyearend.
4.
(C) Therequirementistodeterminethatthefinancialstatementsincludeproperdisclosuresrelatingtoinventory.
AnswerCiscorrectbecauseinventoriespledgedunderloanagreementshouldbedisclosed.
5.
(G)Therequirementistodeterminethatrecordedinventoryisowned.Examininginvoicesisbestbecauseinvoice
willpresentinformationonthepurchase.
TaskBasedSimulation13
Spreadsheet
Completion
Authoritative
Literature
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
A
Holiday Manufacturing Co.
Balance Sheet
December 31, 20X1
Cash
Receivables
Inventory
Total current assets
A
Income Statement
Year ended December 31, 20X1
Selling expenses
General and admin. exp.
Operating income
Less: interest expense
$160,000
100,000
140,000
400,000
Long-term debt
Common stock
Retained earnings
Total liabilities and capital
$2,000,000
MODULE
4
Accounts Payable
Notes payable
Other current liabilities
Total current liabilities
760,000
Total assets
Sales
Cost of goods sold
Materials
Labor
Overhead
Gross margin
$240,000
400,000
600,000
$1,240,000
162
16
17
18
19
20
21
22
23
24
25
26
27
28
29
Help
350,000
750,000
500,000
$2,000,000
RESPONDINGTORISKASSESSMENT
C
$3,000,000
800,000
700,000
300,000
240,000
300,000
1,800,000
1,200,000
540,000
660,000
40,000
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
620,000
220,000
$400,000
Ratios
Current ratio
Quick ratio
Accounts receivable turnover
Inventory turnover
Total asset turnover
Gross margin %
Net operating margin %
Times interest earned
Total debt to equity %
12/31/X1
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
Ratio
1.
(H)
2.
(E)
5.
(D)
6.
(T)
Grossmargin
percentage=
7.
(P)
Netoperating
margin%=
8.
(N)
Currentratio=
SpreadsheetFormula
Currentassets
Currentliabilities
Quickassets*
Currentliabilities
*
Cash+Accountsreceivable.Alsomarketable
securitieswouldbeincludedifthecompanyowned
any.
Sales
3.
(K)Accountsreceivable
Accountsreceivable
turnover=
Costofgoodssold
4. (G)
Inventory
Inventoryturnover=
Quickratio=
Totalassetturnover=
Timesinterestearned=
12/31/X0
2.5
1.3
5.5
2.5
1.2
35%
25%
10.3
50%
Sales
Totalassets
Grossmargin
Sales
Operatingincome
Sales
Operatingincome
Interestexpense
=C8/G8
=(C5+C6)/G8
Calculation
$1,240,000
$400,000
$240,000+$400,000
=
$400,000
=3.1
$1,240,000
$400,000
=3.1
9. (U)
=E19/C6
$3,000,000
$400,000
=7.5
=E23/C7
$1,800,000
$600,000
=3.0
=E19/C13
$3,000,000
$2,000,000
=1.5
=E24/E19
$1,200,000
$3,000,000
=40%
=E28/E19
$660,000
$3,000,000
=22%
=E28/E29
$660,000
$40,000
=16.5
Totaldebttoequity
percentage=
Totaldebt*
Ownersequity**
*Totalcurrentliabilities+Longtermdebt.
**Commonstock+Retainedearnings
=(G8+G10)/(G11+G12)
$400,000+$350,000
$750,000+$500,000
$750,000
=60%
$1,250,000
MODULE5REPORTING
163
REPORTING
thattheclientnotduplicatetherestricteduse
reportforanypurposes.
d. An auditor is not responsible for
controlling the distribution of such
reports.
MULTIPLECHOICEQUESTIONS(1164)
1.
a.
b.
c.
d.
Theobjectiveofanaccountantscompilationof
thefinancialstatementsofanonissuer
(nonpubliccompany)istoprovidewhattypeof
assurance?
Absoluteassurance.
Limitedassurance.
Noassurance.
Reasonableassurance.
2.
Theexistenceofauditriskisrecognizedbythe
statementintheauditorsstandardreportthat
theauditor
a. Obtainsreasonableassuranceabout
whetherthefinancialstatementsarefree
ofmaterialmisstatement.
b. Assessestheaccountingprinciplesused
andalsoevaluatestheoverallfinancial
statementpresentation.
c. Realizessomematters,either
individuallyorintheaggregate,are
importantwhileothermattersarenot
important.
d. Isresponsibleforexpressinganopinion
onthefinancialstatements,whichare
theresponsibilityofmanagement.
3.
Whenanaccountantperformsmorethanonelevel
ofservice(forexample,acompilationanda
review,oracompilationandanaudit)
concerningthefinancialstatementsofanonissuer
(nonpublic)entity,theaccountantgenerally
shouldissuethereportthatisappropriatefor
Thelowestlevelofservicerendered.
Thehighestlevelofservicerendered.
Acompilationengagement.
Areviewengagement.
a.
b.
c.
d.
4.
5.
Whichofthefollowingstatementsiscorrect
concerninganauditorsresponsibilityfor
controllingthedistributionbytheclientofa
restrictedusereport?
a. Anauditormustinformtheclientthata
restrictedusereportisnotintendedfor
distributiontononspecifiedparties.
b. Whenanauditorisawarethataclient
hasdistributedarestrictedusereportto
inappropriatethirdparties,theauditor
shouldimmediatelyinformtheclientto
ceaseanddesist.
Anauditorcontrolsdistributionthroughinsisting
c.
6.
a.
b.
7.
a.
b.
c.
8.
a.
b.
c.
d.
9.
Thedisclosuresprovidereasonable
assurancethatthefinancialstatements
arefreeofmaterialmisstatement.
Theauditorevaluatedtheoverallinternalcontrol.
c. Anauditincludesassessingsignificant
estimatesmadebymanagement.
d. Thefinancialstatementsareconsistent
withthoseofthepriorperiod.
InMay2009,anauditorreissuestheauditors
reportonthe2007financialstatementsata
continuingclientsrequest.The2007financial
statementsarenotrestatedandtheauditordoes
notrevisethewordingofthereport.Theauditor
should
Dualdatethereissuedreport.
Usethereleasedateofthereissuedreport.
Usetheoriginalreportdateonthereissuedreport.
d. Usethecurrentperiodauditorsreport
dateonthereissuedreport.
Whichparagraphsofanauditorsstandardreport
onfinancialstatementsshouldrefertogenerally
acceptedauditingstandards(GAAS)and
generallyacceptedaccountingprinciples
(GAAP)?
GAAS
Opening
Scope
Scope
Opening
GAAP
Scope
Scope
Opinion
Opinion
Anauditorexpressedaqualifiedopiniononthe
prioryearsfinancialstatementsbecauseofalack
ofadequatedisclosure.Thesefinancialstatements
areproperlyrestatedinthecurrentyearand
presentedincomparativeformwiththecurrent
yearsfinancialstatements.Theauditorsup
datedreportontheprioryearsfinancial
statementsshould
a. Beaccompaniedbytheauditorsoriginal
report on the prior years financial
statements.
b. Continue to express a qualified
opinionontheprioryearsfinancial
statements.
c.
Makenoreferencetothetypeof
opinionexpressedontheprioryears
financialstatements.
d.
Expressanunqualifiedopiniononthe
restated financial statements of the
prioryear.
10. Anauditorsresponsibilitytoexpressanopinion
onthefinancialstatementsis
a. Implicitly represented in the auditors
standardreport.
b. Explicitly represented in the opening
paragraph of the auditors standard
report.
c. Explicitly represented in the scope paragraph of
theauditorsstandardreport.
d. Explicitly represented in the opinion
paragraph of the auditors standard
report.
11. Whichofthefollowingphrasesshouldbe
includedintheopinionparagraphwhenanauditor
expressesaqualifiedopinion?
a.
b.
Whenreadin
conjunctionwith
NoteX
Yes
No
Withtheforegoing
Explanation
No
Yes
MODULE5REPORTING
164
a.
c.
d.
Yes
No
a.
b.
c.
d.
Examinationof
evidenceona
testbasis
Explicitly
Implicitly
Implicitly
Explicitly
Consistent
applicationof
accountingprinciples
b.
c.
d.
Itapplies
equallytoa
completeset
offinancial
statements
andtoeach
individual
financial
statement.
It applies only
to a complete
set of financial
statements.
It applies
equally to
each item in
each
financial
statement.
It applies
equallytoeach
material item
in each fi
nancial
statement.
15. Wilson,CPA,completedthe
fieldworkoftheauditofAbcos
December31,2009financial
statementsonMarch6,2010.A
subsequenteventrequiring
adjustmenttothe2009financial
statementsoccurredonApril10,
2010,andcametoWilsons
attentiononApril24,2010.Ifthe
adjustmentismadewithout
disclosureoftheevent,Wilsons
reportordinarilyshouldbedated
a. March6,2010.
b. April10,2010.
c. April24,2010.
d. Usingdualdating.
16. Anauditorissuedanauditreport
thatwasdualdatedforasubsequent
eventoccurringafterthecompletion
offieldworkbutbeforeissuanceof
theauditorsreport.Theauditors
responsibilityforeventsoccurring
subsequenttothecompletionof
fieldworkwas
a. Extended to
subsequent
events
occurring
through the
date
of
issuanceofthe
report.
b. Extended to
include all
events
occurringsince
the completion
offieldwork.
c. Limited to the specific
eventreferenced.
d.
Limited to
include only
events
occurring up to
the date of the
last subsequent
event
referenced.
17. Afinancialstatement
auditreportissuedforthe
auditofanissuer(public)
companyconcludesthat
thefinancialstatements
follow
a. Generally
accepted
accountingprinciples.
b. Public
Company
Accounting
Oversight
Board
standards.
c. Generally
accepted
auditingstandards.
d. International accounting
standards.
18. Whichofthe
followingisnot
correctconcerning
information
includedinanaudit
reportoffinancial
statementsissued
underthe
requirementsofthe
PublicCompany
Accounting
OversightBoard?
a.
Thereport
shouldinclude
thetitleReport
ofIndependent
Registered
Public
Accounting
Firm.
b.
The report
shouldrefer
to the
standards
of the
PCAOB.
Thereport
shouldinclude
aparagraph
referringtothe
auditorsreport
oncompliance
withlawsand
regulations.
The report
should
contain the
city and
state or
country of
the office
that issued
thereport.
c.
d.
19. Aprincipalauditor
decidesnottorefertothe
auditofanotherCPAwho
auditedasubsidiaryofthe
principalauditorsclient.
Aftermakinginquiries
abouttheotherCPAs
professionalreputation
andindependence,the
principalauditormost
likelywould
a. Addan
explanatory
paragraphto
theauditors
report
indicatingthat
thesubsidiarys
financial
statementsare
notmaterialto
the
consolidatedfi
nancial
statements.
b. Documentinthe
engagement
letter that the
principal
auditor assumes
no
responsibility
for the other
CPAsworkand
opinion.
c.
Obtainwritten
permissionfrom
theotherCPAto
omitthe
referenceinthe
principal
auditorsreport.
d.
Contact the
other CPA
andreviewthe
audit pro
grams and
working
papers
pertaining to
the sub
sidiary.
20. The
introductory
paragraphofanauditors
report contains the
followingsentences:
Wedidnotauditthefinancial
statementsofEZInc.,a
whollyownedsubsidiary,
whichstatementsreflecttotal
assetsandrevenues
constituting27%and29%,
respectively,oftherelated
consolidatedtotals.Those
statementswereauditedby
otherauditorswhosereport
hasbeenfurnishedtous,and
ouropinion,insofarasit
relatestotheamounts
includedforEZInc.,isbased
solelyonthereportofthe
otherauditors.
Thesesentences
a. Indicate a division of
responsibility.
b. Assume responsibility for
theotherauditor.
c. Require a departure from
anunqualifiedopinion.
d. Are an improper form of
reporting.
21. Inwhichofthe
followingsituations
wouldanauditor
ordinarilyissuean
unqualifiedauditopinion
withoutanexplanatory
paragraph?
a. The auditor wishes to
emphasize that the entity
had significant related
partytransactions.
b. Theauditor
decidestomake
referencetothe
reportofanother
auditorasa
basis,inpart,for
theauditors
opinion.
MODULE5REPORTING
c.
d.
165
Theentity
issuesfinancial
statementsthat
presentfinancial
positionand
resultsof
operations,but
omitsthe
statementof
cashflows.
Theauditorhassubstantial
doubtabouttheentitys
abilitytocontinueasa
goingconcern,butthecir
cumstancesarefully
disclosedinthefinancial
statements.
c.
d.
opiniononthe
subsidiarys
financial
statements.
Is unable to
review the
auditprograms
and working
papers of the
otherCPA.
Issatisfiedasto
the
independence
and professional
reputationofthe
otherCPA.
24. Whenfinancial
statementsofacompany
thatfollowsGASB
standardswouldbe
misleadingdueto
unusualcircumstances
departfromthose
standards,theauditor
shouldexplainthe
unusualcircumstancesin
aseparateparagraphand
expressanopinionthatis
a. Unqualified.
b. Qualified.
c. Adverse.
d. Qualified or adverse,
dependingonmateriality.
25. Anauditorconcludesthat
thereissubstantialdoubt
aboutanentitysability
tocontinueasagoing
concernforareasonable
periodoftime.Ifthe
entitysfinancialstate
mentsadequatelydisclose
itsfinancialdifficulties,
theauditorsreportis
requiredtoincludean
explanatoryparagraph
thatspecificallyusesthe
phrase(s)
a.
b.
c.
d.
Reasonableperiodof
time,notto
exceed1year
Yes
Yes
No
No
26.Mead,CPA,hadsubstantial
doubtaboutTechCo.sabilityto
continue as a going concern
when reporting on Techs
auditedfinancialstatementsfor
theyearended
June30,2009.Thatdoubthasbeen
removedin2010.WhatisMeads
reportingresponsibilityifTechis
presentingitsfinancialstatements
fortheyearendedJune30,2010,on
Goingconcern
Yes
No
Yes
No
acomparativebasiswiththoseof
2010?
a. The
explanatory
paragraph included in
the 2010 auditors
report should not be
repeated.
b.
Theexplanatory
paragraphincludedinthe
2010auditorsreport
shouldberepeatedinits
entirety.
c.
d.
Adifferent
explanatory
paragraph
describing
Meadsreasons
fortheremoval
ofdoubtshould
beincluded.
Adifferent
explanatory
paragraph
describing
Techsplans
forfinancial
recovery
shouldbein
cluded.
27. Whenanauditor
concludesthereis
substantialdoubtabouta
continuingauditclients
abilitytocontinueasa
goingconcernfora
reasonableperiodof
time,theauditors
responsibilityisto
a. Issueaqualified
oradverse
opinion,
dependingupon
materiality,due
tothepossible
effectsonthe
financial
statements.
b. Consider the
adequacy of
disclosureabout
the clients
possible
inability to
continue as a
goingconcern.
c. Report to the
clients audit
committee
that man
agements
accounting
estimatesmay
need to be
adjusted.
d. Reissuetheprioryears
auditorsreportandadd
anexplanatoryparagraph
thatspecificallyrefersto
substantialdoubtand
goingconcern.
28. Green,CPA,concludes
thatthereissubstantial
doubtaboutJKLCo.s
abilitytocontinueasa
goingconcern.IfJKLs
financialstatements
adequatelydiscloseits
financialdifficulties,
Greensauditorsreport
should
a.
b.
c.
d.
Includean
explanatory
paragraph
followingthe
opinion
paragraph
Yes
Yes
Yes
No
Specifically
usethe
wordsgoing
concern
Yes
Yes
No
Yes
b.
c.
d.
managements
records
retention
policy.
There
is
substantialdoubt
about
the
entitysabilityto
continue as a
goingconcern.
Management
sestimatesof
the effects of
future events
are
unreasonable.
Certain
transactions
cannot
be
tested because
of
30. Afterconsideringan
entitysnegativetrends
andfinancial
difficulties,anauditor
hassubstantialdoubt
abouttheentitysability
tocontinueasagoing
concern.Theauditors
considerationsrelatingto
managementsplansfor
dealingwiththeadverse
effectsofthese
conditionsmostlikely
wouldinclude
managementsplansto
a. Increase current dividend
distributions.
b. Reduce existing lines of
credit.
c. Increaseownershipequity.
d. Purchase assets formerly
leased.
31. Whichofthefollowingconditions
oreventsmostlikelywouldcause
anauditortohavesubstantialdoubt
aboutanentitysabilitytocontinue
asagoingconcern?
a. Signi
fican
t
relate
d
party
trans
actio
ns
are
perva
sive.
MODULE5REPORTING
166
b.
c.
47. Cooper,CPA,believesthereis
substantialdoubtabouttheability
ofZeroCorp.tocontinueasagoing
concernforareasonableperiodof
time.InevaluatingZerosplansfor
dealingwiththeadverseeffectsof
futureconditionsandevents,
Coopermostlikelywouldconsider,
asamitigatingfactor,Zerosplans
to
a. Discusswith
lenders the
terms of all
debt and
loan
agreements.
b. Strengthen controls over
cashdisbursements.
c. Purchase
production
facilities
currently
being leased
from a
related
party.
d. Postpone
expenditures
for research
and develop
mentprojects.
48. Whichofthefollowingconditions
oreventsmostlikelywouldcause
anauditortohavesubstantialdoubt
aboutanentitysabilitytocontinue
asagoingconcern?
a. Cash flows from
operating activities are
negative.
b. Research
and
developmen
t projects
are post
poned.
c. Significant
relatedparty
transactions
arepervasive.
d. Stock dividends replace
annualcashdividends.
49. Whichofthefollowing
auditingproceduresmost
likelywouldassistan
auditorinidentifying
conditionsandeventsthat
mayindicatesubstantial
doubtaboutanentitys
abilitytocontinueasa
goingconcern?
a. Inspecting title
documents to
verify whether
any assets are
pledged as
collateral.
b. Confirming
with third
parties the
details of ar
rangements
to maintain
financial
support.
c.
Reconcilingthe
cashbalanceper
bookswiththe
cutoffbank
statementandthe
bank
confirmation.
d.
Comparingthe
entitys
depreciation
andasset
capitalization
policiesto
otherentities
inthein
dustry.
50. Whichofthefollowing
auditprocedureswould
mostlikelyassistan
auditorinidentifying
conditionsandevents
thatmayindicatethere
couldbesubstantial
doubtaboutanentitys
abilitytocontinueasa
goingconcern?
a. Review
compliancewith
the terms of
debt agree
ments.
b. Confirmation of
accounts
receivable from
principal
customers.
c. Reconciliation
of interest
expense with
debt out
standing.
d. Confirmation of bank
balances.
51. Davis,CPA,believes
thereissubstantial
doubtabouttheability
ofHillCo.tocontinue
asagoingconcernfora
reasonableperiodof
time.Inevaluating
Hillsplansfordealing
withtheadverseeffects
offutureconditionsand
events,Davismost
likelywouldconsider,
asamitigatingfactor,
Hillsplansto
a. Accelerate
research and
development
projects related
to
future
products.
b. Accumulate
treasury stock
at prices
favorable to
Hills historic
pricerange.
c.
d.
Purcha
se
equipm
entand
produc
tion
faciliti
es cur
rently
being
leased.
Negot
iate
reduct
ions
in
requir
ed
divide
nds
being
paid
on
prefer
red
stock.
37. Theadverseeffectsof
eventscausinganauditor
tobelievethereis
substantialdoubtabout
anentitysabilityto
continueasagoing
concernwouldmost
likelybemitigatedby
evidencerelatingtothe
a. Abi
lity
to
exp
and
ope
rati
ons
into
ne
w
pro
duc
t
line
sin
the
fut
ure.
b. Feasib
ilityof
plans
to
purcha
se
leased
equip
ment
at less
than
market
value.
c.
d.
Marke
tabilit
y of
assets
that
manag
ement
plans
tosell.
Co
m
mit
ted
arr
an
ge
me
nts
to
co
nv
ert
pre
fer
red
sto
ck
to
lon
g
ter
m
de
bt.
to
consistency?
a.
d.
Achangeinthe
method of
accounting for
inventories.
b. Achangefrom
anaccounting
principlethatis
notgenerally
acceptedtoone
thatis
generallyac
cepted.
c. A change in
the useful
life used to
calculate the
provisionfor
depreciation
expense.
Managements lack of
reasonablejustificationfor
a change in accounting
principle.
39. Anauditorwouldexpress
an unqualified opinion
with an explanatory
paragraph added to the
auditorsreportfor
a.
b.
c.
d.
Anunjustified
accountingchange
Yes
Yes
No
No
Amaterialweakness
intheinternalcontrol
Yes
No
Yes
No
to
determine the
amounts as
sociatedwithan
employee fraud
scheme.
b. Management does not
provide
reasonable
justificationforachange
inaccountingprinciples.
c. Theclient
refusesto
permitthe
auditorto
confirmcertain
accounts
receivableor
apply
alternative
proceduresto
verifytheir
balances.
d. The chief
executive
officer
is
unwilling to
sign
the
management
representation
letter.
41. DigitCo.usestheFIFO
methodofcostingforits
internationalsubsidiarys
inventoryandLIFOforits
domesticinventory.Under
thesecircumstances,the
auditorsreportonDigits
financialstatementsshould
expressan
a.
b.
d.
Unqualifiedopinion.
Opinionqualifiedbecause
ofalackofconsistency.
c. Opinion
qualified
because of
a departure
from
GAAP.
Adverseopinion.
42. Inthefirstauditofanew
client,anauditorwas
abletoextendauditing
procedurestogather
sufficientevidenceabout
consistency.Underthese
circumstances,the
auditorshould
a.
b.
Notreportontheclients
incomestatement.
Notrefertoconsistencyin
theauditorsreport.
MODULE5REPORTING
c.
43. Whenmanagementdoesnot
providereasonablejustification
thatachangeinaccounting
principleispreferableandit
presentscomparativefinancial
statements,theauditorshould
expressaqualifiedopinion
a. Only in
the year
of the
accountin
g
principle
change.
b. Each year that
the financial
statements
initially re
flecting the
change are
presented.
c. Each year
until
management
changes back
to
the
accounting
principle
formerlyused.
d. Only if the
change is to
an
accounting
principlethat
is
not
generally
accepted.
44. Whenanentitychanges
itsmethodofaccounting
forincometaxes,which
hasamaterialeffecton
comparability,the
auditorshouldreferto
thechangeinan
explanatoryparagraph
addedtotheauditors
report.Thisparagraph
shouldidentifythenature
ofthechangeand
a. Explainwhythechangeis
justified under generally
accepted accounting
principles.
b. Describe the cumulative
effectofthechangeonthe
audited
financial
statements.
c.
d.
167
State
the
auditorsexplicit
concurrence
with or op
position to the
change.
Refer to the
financial
statement note
that discusses
the change in
detail.
45. Anentitychangedfrom
thestraightlinemethod
tothedecliningbalance
methodofdepreciation
forallnewlyacquired
assets.Thischangehasno
materialeffectonthe
currentyearsfinancial
statements,butis
reasonablycertaintohave
asubstantialeffectin
lateryears.Ifthechange
isdisclosedinthenotesto
thefinancialstatements,
theauditorshouldissuea
reportwitha(n)
a. Except for qualified
opinion.
b. Explanatoryparagraph.
c. Unqualifiedopinion.
d. Consistencymodification.
46. Whenreportingon
comparativefinancial
statements,anauditor
ordinarilyshouldchange
thepreviouslyissued
opinionontheprioryears
financialstatementsifthe
a. Prioryears
financial
statementsare
restatedto
conformwith
generally
accepted
accounting
principles.
b. Auditorisa
predecessor
auditorwhohas
beenrequested
byaformer
clienttoreissue
thepreviously
issuedreport.
c.
Prioryears
opinionwas
unqualifiedand
theopinionon
thecurrent
yearsfinancial
statementsis
modifieddueto
alackof
consistency.
d.
Prior years
financial
statements are
restated fol
lowing a
pooling of
interestsinthe
currentyear.
47. Jewel,CPA,audited
InfiniteCo.sprioryear
financialstatements.
Thesestatementsare
presentedwiththoseof
thecurrentyearfor
comparativepurposes
withoutJewelsauditors
report,whichexpresseda
qualifiedopinion.In
draftingthecurrentyears
auditorsreport,Crain,
CPA,thesuccessor
auditor,should
I.NotnameJewelasthe
predecessorauditor.
II.Indicatethetypeofreportissued
byJewel.
Ionly.
IandIIonly.
IIandIIIonly.
I,II,andIII.
48. Beforereissuingtheprior
yearsauditorsreporton
thefinancialstatements
ofaformerclient,the
predecessorauditor
shouldobtainaletterof
representationsfromthe
a.
b.
c.
d.
Formerclientsmanagement
Yes
Yes
No
No
49. Whensingleyear
financialstatementsare
presented,anauditor
ordinarilywouldexpress
anunqualifiedopinionin
anunmodifiedreportif
the
a. Audit
or is
unable
to
obtain
audite
d
financ
ial
state
ments
suppor
ting
the
entity
s
invest
ment
in a
for
eign
affiliat
e.
b. Entity
decline
s to
present
a
stateme
nt of
cash
flows
with its
balance
sheet
and
related
stateme
nts of
in
come
Successorauditor
Yes
No
Yes
No
c.
d.
and
retaine
d
earning
s.
Audito
r
wishes
to
empha
sizean
accoun
ting
matter
affecti
ngthe
compa
rability
ofthe
financi
al
state
ments
with
those
ofthe
prior
year.
Prior
year
s
finan
cial
state
ment
s
were
audit
edby
anoth
er
CPA
whos
e
repor
t,
whic
h
expre
ssed
an
unqu
alifie
d
opini
on,is
not
prese
nted.
50. Aclientispresenting
comparative(twoyear)
financialstatements.
Whichofthefollowingis
correctconcerning
reportingresponsibilities
ofacontinuingauditor?
a.
The
b.
c.
d.
auditor
should
issue
one
audit
report
that is
on
both
present
ed
years.
The
audito
r
should
issue
two
audit
report
s, one
on
each
year.
The
auditor
should
issue
one
audit
report,
but
only
on the
most
recent
year.
The
audit
or
may
issue
either
one
audit
report
on
both
prese
nted
years,
or
two
audit
report
s,one
on
each
year.
51. Thepredecessorauditor,
whoissatisfiedafter
properlycommunicating
withthesuccessorauditor,
hasreissuedareport
becausetheauditclient
desirescomparative
financialstatements.The
predecessorauditors
reportshouldmake
a.
b.
c.
Ref
ere
nce
to
the
rep
ort
of
the
suc
ces
sor
aud
itor
onl
yin
the
sco
pe
par
agr
aph
.
Refer
ence
tothe
work
ofthe
succe
ssor
audit
or in
the
scope
and
opini
on
parag
raphs
.
Refe
renc
e to
both
the
wor
k
and
the
repo
rt of
the
succ
esso
r
audit
or
only
in
the
opin
ion
para
grap
h.
d.
No
refer
ence
tothe
repor
t or
the
work
ofthe
suc
cesso
r
audit
or.
52. Unauditedfinancialstatementsfor
theprioryearpresentedin
comparativeformwithaudited
financialstatementsforthecurrent
yearshouldbeclearlymarkedto
indicatetheirstatusand
I.
Thereport
on the
prior
period
should be
reissuedto
accompan
y the
current
period
report.
19. Thereportonthe
currentperiodshould
includeasaseparate
paragraphadescription
oftheresponsibility
assumedfortheprior
periodsfinancial
statements.
MODULE5REPORTING
168
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
EitherIorII.
53. Inanauditofanonissuer
company,
which
statement is correct
concerning required
supplementary
information by a
designated accounting
standardssetter?
a. The auditor has
no
responsibility
for required
supplementary
information as
long as it is
outside the
basic financial
statements.
b. Theauditors
only
responsibility
forrequired
supplementary
informationis
todetermine
thatsuch
informationhas
notbeen
omitted.
c. Theauditor
shouldapply
certainlimited
proceduresto
therequired
supplementary
information,and
report
deficienciesin,
oromissionsof,
suchin
formation.
d. Theauditor
shouldapply
testsofdetailsof
transactionsand
balancestothe
required
supplementary
information,and
reportany
material
misstatementsin
such
information.
54. Ifmanagementdeclinesto
present supplementary
information required by
the
Governmental
Accounting Standards
a.
b.
c.
55. Ifanauditorisaskedto
provideanopinion
relatingtoinformation
accompanyingthe
financialstatementsina
document,theopinion
willordinarilybeupon
whethertheinformation
isfairlystatedin
a. Accordance
with US
generally
accepted
auditing
standards.
b. Conformity with US
generally
accepted
accountingprinciples.
c. All material
respects in
relation to the
basic financial
statements
taken as a
whole.
d. Accordancewith
attestation
standards
expressing a
conclusionabout
managements
assertions.
56. Anauditorconcludes
thatthereisamaterial
inconsistencyinthe
otherinformationinan
annualreporttoshare
holderscontaining
auditedfinancial
statements.Ifthe
auditorconcludesthat
thefinancialstatements
donotrequirerevision,
buttheclientrefusesto
reviseoreliminatethe
materialinconsistency,
theauditormay
a. Revisetheauditorsreport
to include a separate ex
planatory paragraph
describing the material
inconsistency.
b. Issueanexcept
forqualified
c.
d.
opinionafter
discussingthe
matterwiththe
clientsboardof
directors.
Consider the
matter closed
since the other
information is
not
in the
audited financial
statements.
Disclaim an
opinion on the
financial
statements after
explaining the
material
inconsistency in
a separate
explanatory
paragraph.
57. Whenauditedfinancial
statementsarepresented
inaclientsdocument
containingother
information,theauditor
should
a.
Perform inquiry
and analytical
procedures to
ascertainwhether
the
other
information is
reasonable.
b.
c.
Add
an
explanatory
paragraph to
theauditorsre
port without
changing the
opinion on the
financial
statements.
Perform the appropriate
substantiveauditingproce
dures to corroborate the
otherinformation.
d.
the
audited
financial
statements.
58. Anauditorincludesa
separateparagraphinan
otherwiseunmodified
reporttoemphasizethat
theentitybeingreported
onhadsignificant
transactionswithrelated
parties.Theinclusionof
thisseparateparagraph
a. Is considered
an except
for
qualification
oftheopinion.
b. Violates
generally
accepted
auditing
standardsifthis
informationis
already
disclosedin
footnotestothe
financial
statements.
c. Necessitatesa
revisionofthe
opinion
paragraphto
includethe
phrasewiththe
foregoing
explanation.
d. Is appropriate
andwouldnot
negate the
unqualified
opinion.
59. Anauditorconcludesthat
aclientsillegalact,
whichhasamaterial
effectonthefinancial
statements,hasnotbeen
properlyaccountedforor
disclosed.Dependingon
thematerialityofthe
effectonthefinancial
statements,theauditor
shouldexpresseithera(n)
a. Adverse opinion or a
disclaimerofopinion.
b. Qualified opinion or an
adverseopinion.
c. Disclaimerof
opinionoran
unqualified
opinion with
a separate
explanatory
paragraph.
d. Unqualified
opinion with
a separate
explanatory
paragraph or
a qualified
opinion.
d.
discussedin
the
preceding
paragraph.
Does not presentfairlyin
allmaterialrespects.
61. Inwhichofthefollowing
circumstances would an
auditorbemostlikelyto
express an adverse
opinion?
a.
b.
c.
60. Whichofthefollowing
phraseswouldanauditor
mostlikelyincludein
theauditorsreportwhen
expressingaqualified
opinionbecauseof
inadequatedisclosure?
a.
Subjecttothe
departurefrom
USgenerally
accepted
accounting
principles,as
described
above.
b.
With the
foregoing
explanation
of these
omitted
disclosures.
Except for
theomission
of the
information
c.
d.
The chief
executive
officer refuses
the auditor ac
cess to minutes
of board of
directors
meetings.
Tests of
controlsshow
that the
entitys
internal
control is so
poor that it
cannot
be
reliedupon.
Thefinancial
statementsare
notin
conformity
withtheFASB
Statements
regardingthe
capitalization
ofleases.
Information
comestothe
auditors
attentionthat
raises
substantial
doubtaboutthe
entitysability
tocontinueasa
goingconcern.
62. Whenanauditorqualifies
anopinionbecauseof
inadequatedisclosure,the
auditorshoulddescribe
thenatureoftheomission
inaseparateexplanatory
paragraphandmodifythe
MODULE5REPORTING
a.
b.
c.
d.
Introductory
paragraph
Yes
Yes
No
No
Scope
paragraph
No
Yes
Yes
No
63. Ifapubliclyheld
companyissuesfinancial
statementsthatpurportto
presentitsfinancial
positionandresultsof
operationsbutomitsthe
statementofcashflows,
theauditorordinarilywill
expressa(n)
a. Disclaimerofopinion.
b. Qualifiedopinion.
c. Reviewreport.
d. Unqualified
opinion with
a separate
explanatory
paragraph.
64. Inwhichofthefollowing
situationswouldan
auditorordinarilychoose
betweenexpressingan
exceptforqualified
opinionoranadverse
opinion?
a. The auditor
did
not
observe the
entitys
physical
inventory and
is unable to
become
satisfied as to
its balance by
other auditing
procedures.
b. Thefinancial
statementsfail
todisclose
information
thatisrequired
bygenerally
acceptedac
counting
principles.
c. The auditor is
askedtoreport
only on the
entitys
balance sheet
and noton the
other basic
financial
statements.
d. Events
disclosedinthe
financial
statements
169
cause the
auditor to have
substantial
doubtaboutthe
entitys ability
tocontinueasa
goingconcern.
65. Inwhichofthefollowing
situationswouldan
auditorordinarilychoose
betweenexpressinga
qualifiedopinionoran
adverseopinion?
a. Theauditordid
not observe
the entitys
physical
inventory and
is unable to
become
satisfied about
its balance by
other auditing
procedures.
b. Conditions that
cause
the
auditor to have
substantial
doubt about the
entitys ability
tocontinueasa
going concern
areinadequately
disclosed.
c.
d.
Therehasbeen
a change in
accounting
principles that
has a material
effect on the
comparability
of the entitys
financial
statements.
Theauditoris
unabletoapply
necessary
procedures
concerningan
investorsshare
ofaninves
teesearnings
recognizedon
theequity
method.
66. Inthefirstauditofaclient,an
auditorwasnotabletogather
sufficientevidenceaboutthe
consistentapplicationofaccounting
principlesbetweenthecurrentand
theprioryear,aswellasthe
amountsofassetsorliabilitiesatthe
beginningofthecurrentyear.This
wasduetotheclientsrecordre
tentionpolicies.Iftheamountsin
questioncouldmateriallyaffect
currentoperatingresults,theauditor
would
a. Beunableto
express an
opinion on
the current
years
results of
operations
and cash
flows.
b. Expressa
qualified
opiniononthe
financialstate
mentsbecause
ofaclient
imposedscope
limitation.
c. Withdraw
from the
engagement
and refuse to
be associated
with the
financial
statements.
d. Specifically
state that the
financial
statements are
not
comparable to
the prior year
due to an
uncertainty.
Not
appropriate
because it
may tend
to over
shadowthe
auditors
disclaimer
ofopinion.
b.
Not
appropriate
because the
auditor is
prohibited
from reporting
on only one
basic financial
statement.
c.
Appropriate
providedthe
auditorsscope
paragraph
adequately
describesthe
scope
limitation.
d.
Appropriate
providedthe
statementisina
separate
paragraph
precedingthe
disclaimerof
opinion
paragraph.
69. Park,CPA,wasengaged
toauditthefinancialstate
mentsofTechCo.,anew
client,fortheyearended
December31,2009.Park
obtainedsufficientaudit
evidenceforallofTechs
financialstatementitems
exceptTechsopening
inventory.Dueto
inadequatefinancial
records,Parkcouldnot
verifyTechsJanuary1,
2009inventorybalances.
ParksopiniononTechs
2009financialstatements
mostlikelywillbe
a.
b.
c.
d.
Balancesheet
Disclaimer
Unqualified
Disclaimer
Unqualified
Scope
paragraph
Yes
No
Yes
Yes
Opinion
paragraph
No
Yes
Yes
Yes
71.Harris,CPA,hasbeenasked
toauditandreportonthebalance
sheetofFoxCo.butnotonthe
statementsofincome,retained
earnings,orcashflows.Harris
willhaveaccesstoallinformation
underlyingthebasicfinancial
statements.Underthese
circumstances,Harrismay
a. Not accept the
engagement because it
would constitute a
violation of the
professionsethicalstan
dards.
b.
Incomestatement
Disclaimer
Disclaimer
Adverse
Adverse
c.
Notestothe
financialstatements
Yes
No
No
Yes
MODULE5REPORTING
170
d.
Acceptthe
engagementbut
shoulddisclaim
anopinion
becauseofan
inabilityto
applytheproce
dures
considered
necessary.
72. Whendisclaimingan
opinionduetoaclient
imposedscopelimitation,
anauditorshouldindicate
inaseparateparagraph
whytheauditdidnot
complywithgenerally
acceptedauditing
standards.Theauditor
shouldalsoomitthe
a.
b.
c.
d.
Scope
paragraph
No
Yes
No
Yes
Opinion
paragraph
Yes
Yes
No
No
73. Anauditordecidestoissuea
qualifiedopiniononanentitys
financialstatementsbecausea
majorinadequacyinits
computerizedaccountingrecords
preventstheauditorfromapplying
necessaryprocedures.Theopinion
paragraphoftheauditorsreport
shouldstatethatthequalification
pertainsto
a. A clientimposed scope
limitation.
b. A departure
from generally
accepted
auditing stan
dards.
c. Thepossibleeffectsonthe
financialstatements.
d. Inadequate disclosure of
necessaryinformation.
74. A scope limitation
sufficient to preclude an
unqualified opinion
always will result when
management
a. Prevents the
auditor from
reviewing the
working
papers of the
predecessor
auditor.
b. Engages the
auditorafterthe
yearend
physical in
c.
d.
ventory is
completed.
Requests that
certain material
accounts
receivable not
beconfirmed.
Refusesto
acknowledgeits
responsibility
forthefair
presentationof
thefinancial
statementsin
conformitywith
GAAP.
scope
limitation
prevents the
auditor from
completing an
important audit
procedure.
d. The auditors
report refers to
the work of a
specialist.
76. Anauditormayexpress
anopiniononanentitys
accountsreceivable
balanceevenifthe
auditorhasdisclaimedan
opiniononthefinancial
statementstakenasa
wholeprovidedthe
a. Reportonthe
accounts
receivable
disclosesthe
reasonforthe
disclaimerof
opiniononthe
financial
statements.
b. Distributionof
the report on
the accounts
receivable is
restricted to
internal use
only.
c. Auditor also
reports on the
current asset
d.
portion of the
entitys balance
sheet.
Reportonthe
accounts
receivableis
presented
separatelyfrom
thedisclaimerof
opiniononthe
financial
statements.
auditedfinancialstatementswith
Marchsauditorsreportto1st
FederalBanktoobtainfinancingin
Mondaysattempttopurchase
Wall.Inthesecircumstances,
Marchsauditorsreportwould
usuallybeaddressedto
a. Monday Corp., the client
thatengagedMarch.
b. Wall Corp., the entity
auditedbyMarch.
c. 1stFederalBank.
d. Both Monday Corp. and
1stFederalBank.
78. When an auditor
expressesanadverse
opinion, the opinion
paragraph should
include
a. The principal
effects of the
departure from
generally
accepted
accounting
principles.
b. A
direct
reference to a
separate
paragraph
disclosing the
basis for the
opinion.
c. The
substantive
reasons for
thefinancial
statements
being
misleading.
d. A description of
the uncertainty
or
scope
limitation that
prevents an
unqualified
opinion.
79. An auditor should
disclose the substantive
reasonsforexpressingan
adverse opinion in an
explanatoryparagraph
a.
b.
c.
d.
reviewedthem,theCPA
shouldissueadisclaimer
of opinion. In such
situations, the CPA has
no responsibility to
apply any procedures
beyond
a. Documenting
that internal
control is not
being relied
on.
b. Reading the
financial
statements for
obvious mate
rial
misstatements.
c. Ascertaining
whether the
financial
statements are
in conformity
withGAAP.
d. Determining
whether
management
has elected to
omit
substantially
all required
disclosures.
81. Whenanindependent
CPAisassociatedwith
thefinancialstatements
ofapubliclyheldentity
buthasnotauditedor
reviewedsuch
statements,the
appropriateformof
reporttobeissuedmust
includea(n)
a. Regulation
SX
exemption.
b. Report on pro forma
financialstatements.
c. Unaudited association
report.
d. Disclaimerofopinion.
82. Green,CPA,isawarethatGreens
nameistobeincludedinthe
interimreportofNational
Company,apubliclyheldentity.
Nationalsquarterlyfinancial
statementsarecontainedinthe
interimreport.Greenhasnot
auditedorreviewedtheseinterim
financialstatements.Greenshould
requestthat
I.Greensnamenotbeincludedin
thecommunication.
AI. Thefinancialstatements
bemarkedasunaudited
with a notation that no
opinionisexpressedon
them.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
EitherIorII.
MODULE5REPORTING
83. Theobjectiveofareview
ofinterimfinancial
informationofapublic
entity(issuer)isto
provideanaccountant
withabasisforreporting
whether
a.
b.
c.
Material
modifications
should be made
to conform with
generally
accepted
accounting
principles.
Areasonablebasisexists
forexpressinganupdated
opinionregardingthe
financialstatementsthat
werepreviouslyaudited.
Condensedfinancial
statementsorproforma
financialinformation
shouldbeincludedina
registrationstatement.
d. The financial
statements are
presented fairly
in accordance
with generally
accepted
accountingprin
ciples.
84. Anindependent
accountantsreportis
basedonareviewof
interimfinancial
information.Ifthis
reportispresentedina
registrationstatement,a
prospectusshouldin
cludeastatement
clarifyingthatthe
a. Accountants
review report is
not apartofthe
registration
statement within
the meaning of
the Securities
Actof1933.
b. Accountant
assumesno
responsibility
toupdatethe
reportfor
eventsand
circumstances
occurringafter
thedateofthe
report.
c. Accountants
reviewwas
performedin
171
d.
accordancewith
standards
establishedby
theSecurities
andExchange
Commission.
Accountant
obtained
corroborating
evidence to de
termine whether
material
modificationsare
needed for such
information to
conform with
GAAP.
85. Amodificationofthe
CPAsreportonareview
oftheinterimfinancial
statementsofapublicly
heldcompanywouldbe
necessitatedbywhichof
thefollowing?
a. Anuncertainty.
b. Lackofconsistency.
c. Reference to another
accountant.
d. Inadequatedisclosure.
86. Whichofthefollowing
proceduresordinarily
shouldbeappliedwhen
anindependent
accountantconductsa
reviewofinterim
financialinformationof
apubliclyheldentity?
a. Verify changes in key
accountbalances.
b. Read the
minutes ofthe
board of
directors
meetings.
c. Inspecttheopenpurchase
orderfile.
d. Perform
cutoff tests
for cash
receiptsand
dis
bursements.
87. Whichofthefollowingis
leastlikelytobeaproce
dureincludedinan
accountantsreviewof
interimfinancial
informationofapublic
entity?
a. Compare
disaggregated
revenuedataby
month to that
oftheprevious
interimperiod.
Read available
minutes of
meetings of
stockholders.
Observe counting of
physicalinventory.
d. Inquire of
managemen
tconcerning
significant
journal
entries and
other
adjustments
.
b.
c.
88. Anaccountantsreview
report on interim
financialinformationof
apublicentityismost
likelytoincludea
a.
Statementthat
theinterim
financial
informationwas
examinedin
accordancewith
standardsofthe
PublicCompany
Accounting
OversightBoard.
b.
c.
Statement that
the interim
financial
information is
the
responsibility
of the entitys
shareholders.
Description of the
proceduresforareview.
d. Statementthat
areviewof
interim
financialinfor
mationisless
inscopethana
compilation
conductedin
accordance
withAICPA
standards.
89. Anauditormayreporton
condensedfinancialstate
mentsthatarederived
fromcompletefinancial
statementsifthe
a. Condensed
financial
statementsare
distributedto
stockholders
alongwiththe
complete
financial
statements.
b.
c.
Auditor
described the
additional
procedures
performed on
the condensed
financial
statements.
Auditorindicateswhether
theinformationinthe
condensedfinancial
statementsisfairlystatedin
allmaterialrespectsin
relationtothecomplete
financialstatementsfrom
whichithasbeenderived.
d.
Condensed
financial
statementsare
presentedin
comparative
formwiththe
prioryears
condensed
financial
statements.
90. Anauditorisengagedto
reportonselected
financialdatathatare
includedinaclient
prepareddocumentcon
tainingauditedfinancial
statements.Underthese
circumstances,thereport
ontheselecteddata
should
a.
d.
Be limited to
data derived
from the
audited finan
cialstatements.
b. Be distributed
only to senior
management
and the board
ofdirectors.
c. State that the
presentation is a
comprehensive
basis
of
accounting other
thanGAAP.
Indicate that the data are
notfairlystatedinallma
terialrespects.
91. Beforereportingonthe
financialstatementsofa
USentitythathavebeen
preparedinconformity
withanothercountrys
accountingprinciples,an
auditorpracticinginthe
USshould
a. Understand the
accounting
principles
generally ac
cepted in the
othercountry.
b. Be certified by
the appropriate
auditing or
accountancy
board of the
othercountry.
c.
Notify
management
that the auditor
is required to
disclaim an
opinion on the
financial
statements.
d.
Receive a
waiverfromthe
auditors state
board
of
accountancy to
perform the
engagement.
92. ThefinancialstatementsofKCP
America,aUSentity,areprepared
forinclusionintheconsolidated
financialstatementsofitsnonUS
parent.Thesefinancialstatements
arepreparedinconformitywiththe
accountingprinciplesgenerally
acceptedintheparentscountryand
areforuseonlyinthatcountry.
HowmayKCPAmericasauditor
reportonthesefinancial
statements?
I.AUSstylereport(unmodified).
AI. A USstyle report
modified to report on
the
accounting
principles of the
parentscountry.
III. Thereportformoftheparents
country.
MODULE5 REPORTING
172
a.
b.
c.
d.
I
Yes
No
Yes
No
II
No
Yes
No
Yes
III
No
No
Yes
Yes
93.FieldisanemployeeofGoldEnterprises.Hardy,
CPA,isaskedtoexpressanopiniononFieldsprofitpar
ticipationinGoldsnetincome.Hardymayacceptthisen
gagementonlyif
a. HardyalsoauditsGoldscompletefinancialstate
ments.
b. Goldsfinancialstatementsarepreparedinconfor
mitywithGAAP.
c. Hardysreportisavailablefordistributionto
Goldsotheremployees.
d. FieldownscontrollinginterestinGold.
94.Whenanauditorreportsonfinancialstatementspre
paredonanentitysincometaxbasis,theauditorsreport
should
c.
Applicationofaccountingprinciplestospecified
transactions.
d. Limiteduseprospectivefinancialstatementssuch
asafinancialprojection.
98.DeltaLifeInsuranceCo.preparesitsfinancialstate
mentsonanaccountingbasisinsurancecompaniesusepur
suanttotherulesofastateinsurancecommission.IfWall,
CPA,Deltasauditor,discoversthatthestatementsarenot
suitablytitled,Wallshould
a. Discloseanyreservationsinanexplanatorypara
graphandqualifytheopinion.
b. Applytothestateinsurancecommissionforanad
visoryopinion.
c. Issueaspecialstatutorybasisreportthatclearly
disclaimsanyopinion.
d. Explaininthenotestothefinancialstatementsthe
terminologyused.
99.ACPAispermittedtoacceptaseparateengagement
(notinconjunctionwithanauditoffinancialstatements)to
a.
b.
c.
d.
a.
95.HelpfulCo.,anonprofitentity,prepareditsfinancial
statementsonanaccountingbasisprescribedbyaregulatory
agencysolelyforfilingwiththatagency.Greenauditedthe
financialstatementsinaccordancewithgenerallyaccepted
auditingstandardsandconcludedthatthefinancialstate
mentswerefairlypresentedontheprescribedbasis.Green
shouldissuea
b.
c.
d.
a.
Disclaimanopiniononwhetherthestatements
wereexaminedinaccordancewithgenerallyac
ceptedauditingstandards.
Notexpressanopiniononwhetherthestatements
arepresentedinconformitywiththecomprehen
sivebasisofaccountingused.
Includeanexplanationofhowtheresultsofopera
tionsdifferfromthecashreceiptsanddisburse
mentsbasisofaccounting.
Statethatthebasisofpresentationisacomprehen
sivebasisofaccountingotherthanGAAP.
Qualifiedopinion.
Standardthreeparagraphreportwithreferenceto
footnotedisclosure.
Disclaimerofopinion.
Specialreport.
96.Anauditorsspecialreportonfinancialstatements
preparedinconformitywiththecashbasisofaccounting
shouldincludeaseparateexplanatoryparagraphbeforethe
opinionparagraphthat
Justifiesthereasonsfordepartingfromgenerally
b.
c.
d.
acceptedaccountingprinciples.
Stateswhetherthefinancialstatementsarefairly
presentedinconformitywithanothercomprehen
sivebasisofaccounting.
Referstothenotetothefinancialstatementsthat
describesthebasisofaccounting.
Explainshowtheresultsofoperationsdifferfrom
financialstatementspreparedinconformitywith
generallyacceptedaccountingprinciples.
97.Anauditorsreportwouldbedesignatedaspecialre
portwhenitisissuedinconnectionwith
a. Interimfinancialinformationofapubliclyheld
companythatissubjecttoalimitedreview.
b. Compliancewithaspectsofregulatoryrequire
mentsrelatedtoauditedfinancialstatements.
MODULE5REPORTING
c.
d.
Auditcommittee.
Seniormanagement.
104. Comfortlettersordinarilyare
addressedto
a. Creditor
financial
institutions.
b. The clients audit
committee.
c. The Securities and
ExchangeCommission.
d. Underwritersofsecurities.
105. Whenanaccountantissuestoan
underwriteracomfortletter
containingcommentsondatathat
havenotbeenaudited,the
underwritermostlikelywillreceive
a. Negative assurance on
capsuleinformation.
b. Positive assurance on
d.
auditanentitys
Scheduleof
accountsreceivable
Yes
Yes
No
No
a.
b.
c.
d.
Scheduleof
royalties
Yes
No
Yes
No
100.Financialinformationispresentedinaprintedform
thatprescribesthewordingoftheindependentauditors
report.Theformisnotacceptabletotheauditorbecausethe
formcallsforstatementsthatareinconsistentwiththeaudi
torsresponsibility.Underthesecircumstances,theauditor
mostlikelywould
a. Withdrawfromtheengagement.
b. Rewordtheformorattachaseparatereport.
c. Expressaqualifiedopinionwithanexplanation.
d. Limitdistributionofthereporttothepartywhode
signedtheform.
101.AregistrationstatementfiledwiththeSECcontains
thereportsoftwoindependentauditorsontheirauditsof
financialstatementsfordifferentperiods.Thepredecessor
auditorwhoauditedthepriorperiodfinancialstatements
generallyshouldobtainaletterofrepresentationfromthe
a. Successorindependentauditor.
b. Clientsauditcommittee.
c. Principalunderwriter.
d. SecuritiesandExchangeCommission.
102.Whichofthefollowingstatementsiscorrectconcern
inglettersforunderwriters,commonlyreferredtoascomfort
letters?
a. LettersforunderwritersarerequiredbytheSecuri
tiesActof1933fortheinitialpublicsaleofregis
teredsecurities.
b. Lettersforunderwriterstypicallygivenegativeas
suranceonunauditedinterimfinancialinformation.
c. Lettersforunderwritersusuallyareincludedinthe
registrationstatementaccompanyingaprospectus.
d. Lettersforunderwritersordinarilyupdateauditors
opinionsontheprioryearsfinancialstatements.
103.Comfortlettersordinarilyaresignedbytheclients
a. Independentauditor.
b. Underwriterofsecurities.
173
supplementary
disclosures.
c. A limited
opinion on
pro forma
financial
statements.
A disclaimer on
prospective financial
statements.
106. Whenanindependent
auditreportis
incorporatedbyreference
inaSECregistration
statement,aprospectus
thatincludesastatement
abouttheindependent
accountantsinvolvement
shouldrefertothe
independentaccountant
as
a.
b.
c.
d.
Positive
assurance
concerning
whether
unaudited
condensed
financial
information
compliedwith
generally
accepted
accounting
principles.
d.
Anopinionasto
whetherthe
auditedfinancial
statements
complyinform
withthe
accountingre
quirementsof
theSEC.
108. Whenunaudited
financialstatementsare
presentedincomparative
formwithaudited
financialstatementsina
documentfiledwiththe
SecuritiesandExchange
Commission,such
statementsshouldbe
a.
b.
c.
Markedas
unaudited
Yes
Yes
No
Withheld
until
audited
No
No
Yes
d.
No
Yes
109.Inconnectionwitha
proposaltoobtainanew
auditclient,aCPAinpublic
practiceisaskedtopreparea
reportontheapplicationof
accountingprinciplestoaspecific
transaction.TheCPAsreport
shouldincludeastatementthat
a. Theengagementwas
performedinaccordance
withStatementson
Standardsfor
AccountingandReview
Services.
b.
accounting
treatment rests with the
preparers of the financial
statements.
c.
Theevaluationofthe
applicationofaccounting
principlesishypothetical
andmaynotbeusedfor
opinionshopping.
No
d.
Theguidanceis
providedfor
managements
useonlyand
maynotbe
communicated
totheprioror
continuing
auditor.
c.
entitys audit
committee,
thecontinuing
CPA, and
management.
Disclaimanyopinionthat
the hypothetical applica
tion of accounting
principles conforms with
generally accepted
accountingprinciples.
d. Notifytheentity
thatthereportis
fortherestricted
useof
managementand
outsideparties
whoareaware
ofallrelevant
facts.
110. Inconnectionwitha
proposaltoobtainanew
client,anaccountantin
publicpracticeisaskedto
prepareawrittenreporton
theapplicationof
accountingprinciplestoa
specifictransaction.The
accountantsreportshould
includeastatementthat
112. Whichofthefollowingstatements
a. Anydifference
isnotincludedinanaccountants
in the facts,
circumstances,
reportontheapplicationof
or
as
accountingprinciples?
sumptions
a. Theengagementwas
presented may
performedfollowingstan
change the
dardsestablishedbythe
report.
AmericanInstituteofCer
b. The
tifiedPublicAccountants.
engagement
b. The report is
wasperformed
based on a
inaccordance
hypothetical
withStatements
transactionnot
onStandards
involvingfacts
forConsulting
or
Services.
circumstances
c. The guidance provided is
of this par
for management use only
ticularentity.
and may
not
be
c. The report is
communicatedtotheprior
intended
solely for the
orcontinuingauditors.
information
d. Nothingcame
and use of
tothe
specified
accountants
parties.
attentionthat
d. Responsibilityfor
causedthe
the
proper
accountantto
believethatthe
accounting
accounting
treatment rests
principles
withthepreparers
violatedGAAP.
of the financial
111. Blue,CPA,hasbeenaskedto
renderanopinionontheapplication
ofaccountingprinciplestoa
specifictransactionbyanentitythat
isauditedbyanotherCPA.Blue
mayacceptthisengagement,but
should
a. Consult with
the continuing
CPA to obtain
information
relevant to the
transaction.
b. Report the
engagements
findingstothe
statements.
d.
entitys
compliancewith
requirementsof
specifiedlaws.
The compilation of a
clients
forecast
information.
reportordinarilymayrefer
to
a.
Onlytheassertion.
b. Only the
subject
matter to
which the
assertion
relates.
MODULE5REPORTING
174
c.
d.
Either the
assertionorthe
subject matter
to which the
assertion
relates.
Neither the
assertion
nor the
subject
matter to
which the
assertion
relates.
b.
c.
d.
120. Whichofthefollowingisleastlikely
to be included in an agreedupon
procedures attestation engagement
report?
a.
115. Apractitionerisissuinga
standardunqualified
examinationreportunder
theattestationstandards.
TheCPAsconclusion
maybeon
a.
b.
c.
d.
Subjectmatter
Yes
Yes
No
No
b.
c.
Subjectmatter
Yes
Yes
No
No
a.
b.
c.
d.
InCPAsreport
Yes
No
Yes
No
most likely to be
includedin
Agreedupon procedures
report.
Compilationreport.
Examinationreport.
Reviewreport.
122. Whichofthefollowingis
notcorrectconcerning
specifiedpartiesofan
agreeduponprocedures
reportundereitherthe
auditingorattestation
standards?
Writtenassertion
a.
b.
c.
d.
The specified
party takes
responsibilityfor
the sufficiency
ofprocedures.
Use of the report is
restricted.
Limited assurance on the
informationpresented.
Asummaryofprocedures
performed.
Managements
writtenassertion d.
Yes
No
Yes
121. A summary of findings
No
rather than assurance is
116.Conditionsexistthatresultina
materialdeviationfromthecriteria
againstwhichthesubjectmatter
wasevaluatedduringan
examination.TheCPAsconclusion
maybeon
a.
b.
c.
d.
suitable only
for a limited
numberofpar
ties.
Subject matter available
onlytospecifiedparties.
Awrittenassertionhasnot
beenobtained.
Criteria developed by an
industryassociation.
a.
c.
They must
agree on
the
procedures
to be per
formed.
b. Theymusttake
responsibility
for
the
adequacyofthe
procedures
performed.
They must sign an
engagementletter.
d. After
completion of
the engagement,
another party
maybeaddedas
aspecifieduser.
123. Whenanaccountant
examinesprojected
financialstatements,the
accountantsreportshould
includeaseparate
paragraphthat
a. Describes the
limitations on
the usefulness
of
the
presentation.
b. Provides an
explanation of
the differences
between an
examination and
anaudit.
c. States that the
accountant is
responsible for
events and
circumstances
up to one year
afterthereports
date.
d. Disclaims an
opinion on
whether the
assumptions
provide a
reasonable
basis for the
projection.
124. Anaccountantmay
acceptanengagementto
applyagreedupon
procedurestoprospective
financialstatements
providedthat
a. Use of the
report
is
restrictedtothe
specified par
ties.
b. The
c.
d.
prospective
financial
statements are
also ex
amined.
Responsibility
for
the
adequacyofthe
procedures
performed is
taken by the
accountant.
Negative
assurance is
expressedonthe
prospective
financial
statements taken
asawhole.
125. An accountants
compilationreporton
a financial forecast
should include a
statementthat
a. The forecast
should be
read only in
conjunction
with the
audited
historical
financial
statements.
b. Theaccountantexpresses
onlylimitedassuranceon
theforecastedstatements
andtheirassumptions.
c. There will
usually be
differences
between the
forecasted and
actualresults.
d. The
hypothetical
assumptions
used in the
forecast are
reasonable in
the
circumstances.
126. Accepting
an
engagementtoexamine
an entitys financial
projection most likely
wouldbeappropriateif
the projection were to
bedistributedto
a. All employees who work
fortheentity.
b. Potential
stockholders
who request a
prospectus or a
registration
statement.
c.
d.
A bank with
which the
entity is
negotiatingfor
aloan.
Allstockholdersofrecord
asofthereportdate.
127. ACPAinpublicpracticeisrequired
tocomplywiththeprovisionsofthe
StatementsonStandardsfor
AttestationEngagements(SSAE)
when
Testifyingasan
expertwitnessin
128. An accountingand
accountants
auditingmattersgiven
compilationreporton
stipulatedfacts
a financial
forecast
a. should Yes
include a
b. statementthatthe
Yes
c.
No
a.
d. Compilationdoesnot
No
includeevaluationofthe
MODULE5REPORTING
supportoftheassumptions
underlyingtheforecast.
b. Hypothetical
assumptions
used in the
forecast are
reasonable.
c. Rangeof
assumptions
selectedisone
inwhichone
endoftherange
islesslikelyto
occurthanthe
other.
d. Prospective
statementsare
limitedto
presenting,in
theformofa
forecast,
informationthat
istheac
countants
representation.
129. Whichofthefollowingisa
prospectivefinancialstatementfor
generaluseuponwhichan
accountantmayappropriately
report?
a. Financialprojection.
b. Partialpresentation.
c. Pro forma financial
statement.
d. Financialforecast.
130. Givenoneormore
hypothetical
assumptions,are
sponsiblepartymay
prepare,tothebestofits
knowledgeandbelief,an
entitysexpected
financialposition,results
ofoperations,and
changesinfinancial
position.Suchpro
spectivefinancial
statementsareknownas
a. Pro forma financial
statements.
b. Financialprojections.
c. Partialpresentations.
d. Financialforecasts.
131. Anaccountantmay
acceptanengagementto
applyagreedupon
Compilingaclients
procedurestoprospective
financialprojection
financialstatements
thatpresentsa
providedthat
hypotheticalcourseofa. The
Action
prospective
Yes
financial
No
statements are
Yes
also ex
No
amined.
b.
c.
d.
Responsibility175
for
the
adequacyofthe
procedures
performed is
taken by the
accountant.
Negative
assurance is
expressedonthe
prospective
financial
statements taken
asawhole.
Distribution of
the report is
restrictedtothe
specified
parties.
132. Whenanaccountant
examinesafinancial
forecastthatfailsto
discloseseveral
significantassumptions
usedtopreparethe
forecast,theaccountant
shoulddescribetheas
sumptionsinthe
accountantsreportand
issuea(n)
a. Except for qualified
opinion.
b. Subject to qualified
opinion.
c. Unqualified
opinionwitha
separate
explanatory
paragraph.
d. Adverseopinion.
133. Anaccountantsreport
on a review of pro
forma
financial
information should
includea
a. Statement that
the entitys
internal control
was not relied
oninthereview.
b. Disclaimer of
opinion on the
financial
statementsfrom
which the pro
forma financial
information is
c.
d.
derived.
Caveatthatitis
uncertain
whether the
transaction or
event reflected
intheproforma
financial infor
mation will
everoccur.
Reference to
the financial
statements
fromwhichthe
historical
financial
information is
derived.
134. Whichofthefollowingis
notanobjectiveofa
CPAsexaminationofa
clientsmanagement
discussionandanalysis
(MD&A)prepared
pursuanttoSecuritiesand
ExchangeCommission
rulesandregulations?
a. Thehistorical
amountshave
beenaccurately
derived,inall
material
respects,from
theentitysfi
nancial
statements.
b. The
presentation
isin
conformity
withrulesand
regulations
adoptedby
theSecurities
andEx
change
Commission.
c.
The underlying
information,
determinations,
estimates and
assumptions of
the
entity
provide a rea
sonablebasisfor
the disclosures
containedherein.
d.
The
presentation
includes the
required
elements of
MD&A.
135. Whichofthefollowing
is an assertion
embodied
in
managements
discussionandanalysis
(MD&A)?
a. Valuation.
b. Reliability.
c. Consistency with the
financialstatements.
d. Rightsandobligations.
136. Which of the following
statements is correct
relating to an auditors
review engagements on
anentitysmanagement
discussion and analysis
(MD&A)?
a. A review
c.
consists
principally of
applying
analytical
proceduresand
search and
verification
procedures.
b. The review
report of a
public entity
should be re
stricted to the
use
of
specified
parties.
No consideration of
internal control is
necessary.
d.
The report
issued will
ordinarily
include a
summary of
findings, but
no negative
assurance.
137. Whichofthefollowingisatermfor
anattestengagementinwhichaCPA
assessesaclientscommercial
Internetsiteforpredefinedcriteria
suchasthoseoveronlineprivacy?
a.
b.
c.
d.
ElectroNet.
EDIFACT.
TechSafe.
WebTrust.
138. Trust
Service
engagements are
performed under the
provisionsof
a. Statements on Assurance
c.
d.
Standards.
b. Statements on
Standards for
Attestation
Engagements.
Statements on Standards
forTrustEngagements
Statements on Auditing
Standards.
assurance
procedures.
d. Websites.
140. A CPAs examination
report relating to a
WebTrust engagement
is most likely to
include
a. Anopiniononwhetherthe
siteishackproof.
b. An opinion
on whether
the site
meets the
WebTrust
criteria.
c. Negative assurance on
whether the site is
electronicallysecure.
d. No opinion or
other
assurance, but
a summary of
findings
relating to the
Website.
MODULE5REPORTING
176
141. Anengagementinwhich
aCPAconsiderssecurity,
availability,processing
integrity,onlineprivacy,
and/orconfidentiality
overanytypeofdefined
electronicsystemismost
likelytoconsidered
whichofthefollowing
typesofengagements?
a. Internal control over
financialreporting.
b. SysTrust.
c. WebsiteAssociate.
d. WebTrust.
142. Aclientsrefusalto
provideawritten
assertioninaTrust
Servicesengagementis
mostlikelytoresultin
whichofthefollowing
typesofopinions?
a. Adverse.
b. Disclaimer.
c. Qualified.
d. Unqualified
with
explanatorylanguage.
143. Whichofthefollowing
typesofengagementsis
notpermittedunderthe
professionalstandards
forreportingonan
entityscompliance?
a. Agreedupon
procedures on
compliance
with the
specified
requirements
ofalaw.
b. Agreedupon
procedures on
the effectiveness
of internal
control over
compliance with
alaw.
c. Review on
compliance with
specified
requirements of
alaw.
d. Examination on
compliance with
specified
requirements of
alaw.
144. Mill,CPA,wasengaged
byagroupofroyalty
recipientstoapply
agreeduponprocedures
tofinancialdatasup
a.
pliedbyModernCo.
regardingModerns
writtenassertionabout
itscompliancewith
contractualrequirements
topayroyalties.Mills
reportontheseagreed
uponproceduresshould
containa(n)
Disclaimer of opinion
aboutthefairpresentation
of Moderns financial
statements.
b. List of the
procedures
performed
(or
reference
thereto)and
Mills
findings.
c.
Opinion about
the effectiveness
of Moderns
internal control
activities
concerning
royalty
payments.
147. Inauditinganotforprofit
entitythatreceives
governmentalfinancial
assistance,theauditorhas
aresponsibilityto
a. Issueaseparatereportthat
describestheexpected
benefitsandrelatedcosts
oftheauditorssuggested
changestotheentitys
internalcontrol.
b. Assesswhether
management
hasidentified
lawsand
regulationsthat
haveadirect
andmaterialef
fectonthe
entitys
financial
statements.
c. Notify the
governmental
agency
providingthefi
nancial
assistance that
theauditis not
designed to
provide any
assurance of
detecting
misstatements
andfraud.
d. Renderan
opinion
concerningthe
entityscontin
uedeligibility
forthe
governmental
financialas
sistance.
148. Hill,CPA,isauditingthefinancial
statementsofHelpingHand,anot
forprofitorganizationthatreceives
financialassistancefrom
governmentalagencies.Todetect
misstatementsinHelpingHands
financialstatementsresultingfrom
violationsoflawsandregulations,
Hillshouldfocusonviolationsthat
a. Could result in
criminal
prosecution
against the or
ganization.
b. Involve
significant
deficienciesto
becommuni
catedtothe
organizations
trusteesandthe
funding
agencies.
Have a direct
and material
effect on the
amounts in the
organizations
financial
statements.
Demonstratetheexistence
ofmaterialweaknesses.
c.
d.
149. Agovernmentalauditmayextend
beyondanexaminationleadingto
theexpressionofanopiniononthe
fairnessoffinancialpresentationto
include
2.
a.
b.
c.
d.
Program
results
Yes
Yes
No
Yes
Compliance
Yes
Yes
Yes
No
Economy&
efficiency
No
Yes
Yes
Yes
Acknowledgmentthatthesufficiencyoftheproce150.Whenauditingan
entitysfinancialstatementsinac
duresissolelyMills
cordancewithGovernment
responsibility.
AuditingStandards(the
YellowBook),anauditoris
145. ACPAsreporton
requiredtoreporton
agreeduponprocedures
I. Noteworthy accomplishments
relatedtoanentitys
oftheprogram.
compliancewith
II. The scope of the auditors
specifiedrequirements
testingofinternalcontrols.
shouldcontain
a. Astatementoflimitations
a. Ionly.
ontheuseofthereport.
b. IIonly.
b. Anopinionaboutwhether
c. BothIandII.
managementsassertionis
d. NeitherInorII.
fairlystated.
c. Negative
151.Whenauditinganentitys
assurance that
financialstatementsinaccordance
control risk
withGovernmentAuditing
has not been
Standards(theYellowBook),an
assessed.
auditorisrequiredtoreporton
d. An acknowledgment of
I.Recommendationsforactionsto
responsibilityforthesuffi
improveoperations.
ciencyoftheprocedures.
146. Whenreportingonan
examinationofa
companyscompliance
withrequirementsof
specifiedlaws,thepracti
tionerhasidentifiedan
instanceofmaterial
noncompliance.
Managementhasagreed
toincludethisinstancein
itswrittenassertion.The
examinationreportshould
include
a. Nomodificationfromthe
standardform.
b. An opinion
paragraphthat
is unqualified,
and
an
explanatory
paragraph.
c. A qualified or adverse
opinion.
d. Adisclaimerofopinion.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
NeitherInorII.
MODULE5REPORTING
152. Which of the following
statements is a standard
applicable to financial
statement audits in
accordance with Gov
ernment
Auditing
Standards (the Yellow
Book)?
a. An auditor
should report
onthescopeof
the auditors
testing of
compliance
with laws and
regulations.
b. Anauditor
shouldassess
whetherthe
entityhasre
portable
measuresof
economyand
efficiencythat
arevalidand
reliable.
c. An auditor
should report
recommendatio
ns for actions
to correct
problems and
improve
operations.
d. An auditor
should
determine the
extent to
which the
entitys
programs
achieve the
desiredresults.
153. Which of the following
statements is a standard
applicable to financial
statement audits in
accordance with Gov
ernment
Auditing
Standards (the Yellow
Book)?
a. An auditor
should report
onthescopeof
the auditors
testing of
internal
controls.
b.
All instances of
abuse,waste,and
mismanagement
should
be
reported to the
auditcommittee.
177
c.
An auditor
should report
the views of
responsible
officials
concerning the
auditors
findings.
d.
Internal control
activities
designed to
detect or pre
vent fraud
should
be
reported to the
inspector gen
eral.
154. Inreportingunder
GovernmentAuditing
Standards,anauditormost
likelywouldberequired
toreportafalsificationof
accountingrecords
directlytoafederal
inspectorgeneralwhenthe
falsificationis
a. Discoveredafter
theauditors
reporthasbeen
madeavailable
tothefederal
inspectorgeneral
andtothe
public.
b. Reported by the
auditor to the
audit committee
as a significant
deficiency in
internalcontrol.
c. Voluntarily
disclosed to
theauditorby
lowlevel
personnelasa
result of the
auditors
inquiries.
d. Communicate
d by the
auditor to the
auditee and
the auditee
fails to make
a required
report of the
matter.
155. Althoughthescopeof
auditsofrecipientsof
federalfinancial
assistanceinaccordance
withfederalauditregula
tionsvaries,theseaudits
generallyhavewhichof
thefollowingelements
incommon?
b. To specific
a. The auditor is
legislative and
to determine
whether the
regulatory
federal fi
bodies when
nancial
reporting under
assistance has
Government
been
Auditing
administered in
Standards.
accordance
c. Toacourt
with applicable
appointed
laws
and
creditors
regulations.
committeewhen
b. Thematerialitylevelsare
theclientis
lowerandaredetermined
operatingunder
bythegovernmententities
Chapter11of
thatprovidedthefederal
theFederal
financialassistancetothe
Bankruptcy
recipient.
Code.
c. Theauditorshouldobtain
d. Toshareholders
writtenmanagementrep
withsignificant
resentationsthatthe
influence(more
recipientsinternal
than20%equity
auditorswillreporttheir
ownership)when
findingsobjectively
significantdefi
withoutfearofpolitical
cienciesare
repercussion.
deemedtobe
d. Theauditoris
material
requiredto
weaknesses.
expressboth
positiveand
157. Wolfisauditinganentitys
negative
compliancewithrequirements
assurancethat
governingamajorfederalfinancial
illegalactsthat
assistanceprograminaccordance
couldhavea
withGovernmentAuditing
materialeffect
Standards.Wolfdetected
ontherecipients
noncompliancewithrequirements
financialstate
thathaveamaterialeffectonthe
mentsare
program.Wolfsreporton
disclosedtothe
complianceshouldexpress
inspector
a. No assurance on the
general.
compliancetests.
b. Reasonable assurance on
156. An auditor most likely
thecompliancetests.
wouldberesponsiblefor
c. A qualified or adverse
communicating
opinion.
significantdeficienciesin
d. An adverse or disclaimer
the design of internal
ofopinion.
control
a. TotheSecurities
158. Whichofthefollowing
and Exchange
isaspecific
Commission
documentation
when the client
requirementthatan
is a publicly
auditorshouldfollow
heldentity.
whenauditingin
accordancewith
GovernmentAuditing
Standards?
a.
Theauditor
shouldobtain
written
representations
from
management
acknowledging
responsibilityfor
correcting
instancesof
fraud,abuse,and
waste.
b.
c.
d.
Beforethereport
is
issued,
evidence of
supervisory
review of the
audit.
The auditor
should
document the
procedures that
assure
discoveryofall
illegal acts and
contingent
liabilities
resulting from
noncompliance.
Theauditors
workingpapers
shouldcontain
acaveatthat
allinstancesof
material
misstatements
andfraudmay
notbe
identified.
159. Inperforminga
financialstatementaudit
inaccordancewith
GovernmentAuditing
Standards,anauditoris
requiredtoreportonthe
entityscompliancewith
lawsandregulations.
Thisreportshould
a. State that
compliance
with laws and
regulations is
the
responsibility
of the entitys
management.
b. Describe the
laws and
regulations
thattheentity
must comply
with.
c. Provide an
opinion on
overall
compliance
with laws
and
regulations.
d. Indicatethat
the auditor
does
not
possess
legal skills
and cannot
make legal
judgments.
160. Inreportingunder
GovernmentAuditing
Standards,anauditormost
likelywouldberequired
tocommunicateman
agements
misappropriationofassets
directlytoafederal
inspectorgeneralwhenthe
fraudulentactivitiesare
a. Concealed by
managementby
circumventing
specific
internal
controls
designed to
safeguard those
assets.
b. Reportedto
theentitys
governing
bodyandthe
governing
bodyfailsto
makea
requiredreport
tothefederal
inspector
general.
c.
d.
Accompanied by
fraudulent
financial
reporting that
resultsinmaterial
misstatements of
assetbalances.
Perpetrated by
several levels
ofmanagement
in a scheme
thatislikelyto
continue in
futureyears.
161. Inauditingcompliance
withrequirements
governingmajorfederal
financialassistance
programsundertheSingle
AuditAct,theauditors
considerationofmateriality
differs
178
MODULE5REPORTING
frommaterialityundergenerallyacceptedauditingstan
dards.UndertheSingleAuditAct,materialityis
a. Calculatedinrelationtothefinancial
statementstakenasawhole.
b. Determinedseparatelyforeachmajor
federalfinancialassistanceprogram.
c. Decided in conjunction with the
auditorsriskassessment.
d. Ignored,becauseallaccountbalances,
regardlessofsize,arefullytested.
162. Kentisauditinganentityscompliancewith
requirementsgoverningamajorfederalfinancial
assistanceprograminaccordancewiththeSingle
AuditAct.Kentdetectednoncompliancewith
requirementsthathaveamaterialeffectonthat
program.Kentsreportoncomplianceshould
expressa(n)
a. Unqualified opinion with a separate
explanatoryparagraph.
b. Qualifiedopinionoranadverseopinion.
c. Adverseopinionoradisclaimerofopinion.
d. Limitedassuranceontheitemstested.
163. When performing an audit of a city that is
subject to the requirements of the Uniform
Single Audit Act of 1984, an auditor should
adhereto
a. Governmental Accounting Standards
BoardGeneralStandards.
b. GovernmentalFinanceOfficers
AssociationGovernmental
Accounting,Auditing,andFinancial
ReportingPrinciples.
c. General Accounting Office
GovernmentAuditingStandards.
d. Securities and Exchange Commission
RegulationSX.
164. ACPAhasperformedanexaminationofthe
generalpurposefinancialstatementsofBigCity.
Theexaminationscopeincludedtheadditional
requirementsoftheSingleAuditAct.When
reportingonBigCitysinternalaccountingand
administrativecontrolsusedinadministeringa
federalfinancialassistanceprogram,theCPA
should
a. Communicate those weaknesses that
arematerialinrelationtothegeneral
purposefinancialstatements.
b. Expressanopiniononthesystemsused
toadministermajorfederalfinancial
assistanceprogramsandexpress
negativeassuranceonthesystemsused
toadministernonmajorfederalfinancial
assistanceprograms.
c. Communicate those weaknesses that
are material in relation to the federal
financialassistanceprogram.
d. Expressnegativeassuranceonthe
systemsusedtoadministermajorfederal
financialassistanceprogramsand
expressnoopiniononthesystemsused
toadministernonmajorfederalfinancial
assistanceprograms.
MODULE5REPORTING
SIMULATIONS
TaskBasedSimulation1
Accounting
Changes
Authoritative
Literature
Help
TheauditofParkPublishingCo.,fortheyearendedSeptember30,20X2,
isnearcompletion.Yoursenior,DaveMoore,atTyler&TylerCPAs,has
askedyoutodrafttheauditreport,consideringthefollowing:
2.
3.
4.
Duringfiscalyear20X2,Parkchangeditsdepreciation
method.Theengagementpartnerconcurredwiththis
changeinaccountingprincipleanditsjustification,and
Moorewantsitproperlyreflectedintheauditorsreport;
thechangeisdiscussedinNote7tothefinancial
statements.
The20X2financialstatementsareaffectedbyan
uncertaintyconcerningalawsuitoverpatentinfringement,
theoutcomeofwhichcannotpresentlybeestimated.Moore
hassuggestedtheneedforanexplanatoryparagraphinthe
auditorsreportrelatedtothismatterwhichisdiscussedin
Note4tothefinancialstatements.
ThefinancialstatementsfortheyearendedSeptember30,
20X1, are to be presented for comparative purposes.
Wilson&Wilsonpreviouslyauditedthesestatementsand
expressedastandardunqualifiedopinion.
IdentifytheparagraphsintheProfessionalStandardsthatprovide
guidance regarding the modification of the audit report for the
changeinaccountingprinciple.
IdentifytheparagraphinProfessionalStandardsthatprovidesthe
guidance regarding the modification of the audit report for the
uncertainty.
IdentifytheparagraphsintheProfessionalStandardsthatprovide
theguidanceregardingtheeffectofWilson&Wilsonsopinionon
the20X1financialstatementsonTyler&Tylersauditreporton
the20X2financialstatements.
TaskBasedSimulation2
Report
Modifications
Authoritative
Literature
Help
Assumethatitems1through8aresituationsthatJones,CPA,has
encounteredduringhisauditofWellesIncorporated.ListArepresentsthe
typesofopinionstheauditorordinarilywouldissueandListBrepresentsthe
reportmodifications(ifany)thatwouldbenecessary.Foreachsituation,select
oneresponsefromListAandonefromListB.Selectasthebestanswersfor
eachitemtheactiontheauditorwouldnormallytake.Thetypesofopinionsin
ListAandthereportmodificationsinListBmaybeselectedonce,morethan
once,ornotatall.
Assume
Theauditorisindependent.
Theauditorpreviouslyexpressedanunqualifiedopinionontheprior
179
yearsfinancialstatements.
Only singleyear (not comparative) statements are presented for the
currentyear.
Theconditionsforanunqualifiedopinionexistunlesscontradictedby
thefacts.
Theconditionsstatedintheitemstobeansweredarematerial,unless
otherwiseindicated.
Eachitemtobeansweredisindependentoftheothers.
Noreportmodificationsaretobemadeexceptinresponsetothefactual
situation.
Theauditorwillnottreatasituationasanemphasisofamatterin
whatremainsanunqualifiedauditreportunlessitisoneofthose
circumstancesspecificallyillustratedintheProfessionalStandardsasan
exampleofamatteranauditormaywishtoemphasize.
180
MODULE5
ListA
Typesofopinions
A. Either an except for
qualified opinion or an
adverseopinion
B. Either a disclaimer of
opinion or an except
forqualifiedopinion
C. Either an adverse
opinionoradisclaimer
ofopinion
D. An except for qualified
opinion
E. Anunqualifiedopinion
F. Anadverseopinion
G. Adisclaimerofopinion
REPORTING
ListB
Reportmodifications
H. Describe
the
circumstances in an
explanatory paragraph
without modifying the
three standard para
graphs.
I. Describe
the
circumstances in an
explanatory paragraph
and modify the opinion
paragraph.
J. Describethe
circumstancesinan
explanatoryparagraph
andmodifythescopeand
opinionparagraphs.
K. Describethe
circumstancesinan
explanatoryparagraph
andmodifythe
introductory,scope,and
opinionparagraphs.
L.
Describe
the
circumstances within the
scope paragraph without
adding an explanatory
paragraph.
P.
1.
2.
3.
Typesof
Report
opinions modifications
(AG)
(HP)
JoneshiredanactuarytoassistincorroboratingWellescomplex
pensioncalculationsconcerningaccruedpensionliabilitiesthat
accountfor35%oftheclientstotalliabilities.Theactuarysfindings
arereasonablyclosetoWellescalculationsandsupportthefinancial
statements.
Wellesholdsanotereceivableconsistingofprincipalandaccrued
interestpayablein20X4.Thenotesmakerrecentlyfileda
voluntarybankruptcypetition,butWellesfailedtoreducethe
recordedvalueofthenotetoitsnetrealizablevalue,whichis
approximately20%oftherecordedamount.
Joneswasengagedtoauditaclientsfinancialstatementsaftertheannual
physicalinventorycount.Theaccountingrecordswerenotsufficiently
reliabletoenablehimtobecomesatisfiedastotheyearendinventory
balances.
4.
Jonesfoundanimmaterialadjustmentrelatingtoinventory.Welles
has refused to adjust the financial statements to reflect this
immaterialitem.
5.
Wellesfinancialstatementsdonotdisclosecertainlongtermlease
obligations. Jones determined that the omitted disclosures are
requiredbyFASB.
6.
JonesdecidednottotakeresponsibilityfortheworkofanotherCPA
whoauditedawhollyownedsubsidiaryofWelles.Thetotalassets
andrevenuesofthesubsidiaryrepresent27%and28%,respectively,
oftherelatedconsolidatedtotals.
7.
Welleschangeditsmethodofaccountingforthecostof
inventoriesfromFIFOtoLIFO.Jonesconcurswiththechange
althoughithasamaterialeffectonthecomparabilityofthe
financialstatements.
8.
Duetolossesandadversekeyfinancialratios,Joneshassubstantial
doubtaboutWellesabilitytocontinueasagoingconcernfora
reasonableperiodoftime.Theclienthasadequatelydisclosedits
financialdifficultiesinanotetoitsfinancialstatements,whichdo
notincludeanyadjustmentsthatmightresultfromtheoutcomeof
thisuncertainty.Also,Joneshasruledouttheuseofadisclaimerof
opinion.
MODULE5REPORTING
TaskBasedSimulation3
Research
Authoritative
Literature
Help
ContactingaPredecessorAuditor
YourecentlygraduatedfromcollegeandhaveworkedwithTice&
Co.CPAsforseveralmonths.ApartnerinTicehasindicatedthatthefirm
hasapotentialnonpublicnewauditclientandthathewouldliketo
researchthemattersthatareordinarilyaddressedbyasuccessorauditors
inquiryofthepredecessorauditorpriortoacceptinganewengagement.
Selections
A. AU
B. PCAOB
C. AT
D. AR
E. ET
F. BL
181
G. CS
H. QC
(A)(B)(C)(D)(E)(F)(G)(H)
1. WhichtitleoftheProfessionalStandardsaddressesthisissueandwillbe
helpfulinrespondingtothepartner?
2. Entertheexactsectionandparagraphwiththeappropriateguidance.
TaskBasedSimulation4
Research
Authoritative
Literature
Help
StandardReportElements
ThesenioronyourjobhaspointedouttoyouthattheCPAfirm
alwayssignsthereportbothwithitssignatureanditslocation(Yuma,
Arizona) and that she suggests that she thinks it isnt necessary to
providethelocation.
1.
Identifythetitle,section,andparagraphoftheauditingstandards
that provide the basic elements that must be included in the
auditorsstandardreport.
2. Isshecorrectorincorrectconcerninginclusionofthelocation?
Yes No
TaskBasedSimulation5
AuditReport
Details
Authoritative
Literature
Help
OnSeptember30,20X2,White&Co.CPAswasengagedtoauditthe
consolidatedfinancialstatementsofNationalMotorsInc.fortheyearended
December31,20X2.TheconsolidatedfinancialstatementsofNationalhadnot
beenauditedtheprioryear.Nationalsinadequateinventoryrecordsprecluded
Whitefromforminganopinionastotheproperapplicationofgenerally
acceptedaccountingprinciplestoinventorybalancesonJanuary1,20X2.
Therefore,Whitedecidednottoexpressanopinionontheresultsofoperations
fortheyearendedDecember31,20X2.Nationaldecidednottopresent
comparativefinancialstatements.
RapidPartsCompany,aconsolidatedsubsidiaryofNational,wasaudited
fortheyearendedDecember31,20X2,byGreen&Co.CPAs.Green
completeditsauditproceduresonFebruary28,20X3,andsubmittedan
unqualifiedopiniononRapidsfinancialstatementsonMarch7,20X3.Rapids
statementsreflecttotalassetsandrevenuesconstituting$700,000and
$2,000,000,respectively,oftheconsolidatedtotalsofNational.Whitedecided
nottoassumeresponsibilityfortheworkofGreen.GreensreportonRapid
doesnotaccompanyNationalsconsolidatedstatements.
ThefollowinglistspotentialeffectsonWhitesauditreport.
MODULE5REPORTING
182
A.
B.
C.
D.
E.
F.
G.
H.
I.
J.
K.
L.
EffectontheAuditReport
Disclaimonbalancesheet,incomestatementandstatementofcashflows.
Disclaimonlyonresultsofoperations.
Qualifiedauditopiniononresultsofoperations.
Modificationofreporttosetforthadivisionofresponsibilityfortheaudit.
Issuanceoftwoseparatereports.
DatethereportMarch28,20X3.
DatethereportApril4,20X3.
ManagementofNationalMotors.
NationalMotorsBoardofDirectors.
ManagementsofbothNationalMotorsandRapidParts.
White&Co.only.
White&Co.andGreen&Co.
Foreachcircumstancedescribedbelowselectthemostappropriatestatementthatreflectstheeffectordetailsofthe
auditreport.
1.
N
a
2.
R
a
3.
W
h
4
5
MODULE5 REPORTING
183
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
7.
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c
a
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a
d
c
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c
a
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c
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c
a
d
d
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b
c
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c
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b
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a
b
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b
d
d
a
a
d
b
c
c
c
a
a
d
a
d
d
c
b
a
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b
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a
d
a
d
d
a
b
a
a
b
c
c
a
b
a
a
d
c
a
c
a
a
c
c
c
a
d
b
d
d
d
b
c
b
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MULTIPLECHOICEANSWEREXPLANATIONS
A.1.OverallIssues
1.
(c)Therequirementistoidentifythetypeofassurance(if
any)providedinafinancialstatementcompilationreport.
Answer(c)iscorrectbecausetheobjectiveofa
compilationistopresentintheformoffinancialstatements
informationthatisthepresentationofmanagement
(owners)withoutundertakingtoexpressanyassuranceon
thestatements.Answer(a)isincorrectbecauseaccountants
neverprovideabsoluteassurance.Answer(b)isincorrect
becausereviewsresultinlimited(negative)assurance.
Answer(d)isincorrectbecauseaudits,notcompilations,
providedreasonableassurance.
2.
(a)Therequirementistoidentifythestatementin
thestandardauditreportthatindicatesthe
existenceofauditrisk.Answer(a)iscorrect
becausetheexistenceofauditriskisrecognized
bythestatementintheauditorsstandardreport
thattheauditorobtainedreasonableassurance.
Answer(b)isincorrectbecausewhilethe
standardreportdoesindicatethattheCPA
assessestheaccountingprinciplesusedandthe
overallfinancialstatementpresentation,thisdoes
notindicatetheexistenceofauditrisk.Answer
(c)isincorrectbecausewhilethestandardreport
doesindicatethattheauditrelatestowhetherthe
financialstatementsarefreeofmaterial
misstatement,itdoesnotdiscussmaterialityand
theauditriskassociatedwithmateriality.Answer
(d)is
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137.
138.
139.
140.
141.
142.
143.
144.
145.
146.
147.
148.
149.
150.
151.
152.
153.
154.
155.
156.
157.
158.
159.
160.
161.
162.
163.
164.
1st:
2nd:
d
b
d
b
b
b
c
b
a
c
b
c
b
b
b
a
a
d
a
b
c
b
a
b
b
b
c
c
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__/164=__%
__/164=__%
incorrectbecausewhilethefinancialstatementsarethere
sponsibilityofmanagementandtheCPAsresponsibility
istoexpressanopinion,theindicationthattheCPA
expressesanopiniondoesnotaddressauditriskandisless
precisethanthestatementthattheauditorobtains
reasonableassurance.
3.
(b)Therequirementistodeterminean
accountantsreportingresponsibilitywhenmore
thanonelevelofserviceconcerningthefinancial
statementsofanonissuer(nonpublic)entityhas
beenperformed.Answer(b)iscorrectbecause
AR100requiresthattheaccountantreportonthe
highestlevelofservicerendered.Answer(a)is
incorrectbecausethehighest,andnotthelowest,
levelisreportedon.Answer(c)isincorrect
becauseregardlessoftheothertypeofservice
performed,thecompilationlevelisalwaysthe
lowestlevelandthereforeshouldnotbethebasis
ofthereport.Answer(d)isincorrectbecausein
circumstancesinwhichanaudithasbeen
performed,anauditreport,notareviewreport,is
appropriate.
4.
(c)Therequirementistoidentifythereportthatisleastlikely
tobearestrictedusereport.Answer(c)iscorrectbecause
AU623indicatesthatreportsonmostcomprehensivebasis
financialstatementsarenotrestricted.Answers(a)and(b)
areincorrectbecausereportsonsignificantdeficienciesand
reportstoauditcommitteesarerestricted
MODULE5REPORTING
184
standardsandgenerallyacceptedac
countingprinciples.Answer(c)is
correctbecausethescopeparagraph
indicatesthatgenerallyaccepted
auditingstandardshavebeen
followed,whiletheopinion
paragraphindicatesthatthe
financialstatementsfollow
generallyacceptedaccounting
principles.
underAU325andAU380,
respectively.Answer(d)is
incorrectbecauseAU623
restrictssuchreportsoncompli
ance.Also,seeAU532for
informationonrestrictingtheuse
ofanauditreport.
5.(d)Therequirementisto
determinean
auditorsresponsibilityfor
controllingthedistributionbythe
clientofarestrictedusereport.
Answer(d)iscorrectbecauseAU
532statesthatanauditorisnot
responsibleforcontrollingthe
distributionofsuchreports.
Answer(a)isincorrectbecause
whileanauditorshouldconsider
informingaclientthatrestricted
usereportsarenotintendedfor
suchdistribution,thereisnosuch
requirement.Answer(b)is
incorrectbecausetheauditorneed
notinformtheclienttoceaseand
desist.Answer(c)isincorrect
becauseanauditorneednotinsist
thattheclientnotduplicatethe
restrictedusereport.
A.2. FinancialStatementAudit
ReportsNonissuer
(Nonpublic)Companies
6.
(c)Therequirementisto
identifythestatementthat
isincludedinthe
auditorsstandardreport.
Answer(c)iscorrect
becausetheauditors
standardreportstatesthat
anauditincludes
assessingsignificant
estimatesmadebyman
agement;seeAU508for
thisandotherrequired
elementsincludedina
standardreport.
7.
(c)Therequirementisto
determinetheproperdate
ofareissuedauditreport
on financial statements
thathave
notbeenrestated.Answer(c)is
correctbecauseuseoftheoriginal
dateonthereissuedauditreport
removesanyimplicationthat
records,transactionsoreventsafter
thedateoftheauditreporthave
beenexaminedorreviewed.
8.
(c)Therequirementistoidentify
whichparagraphofanauditors
standardauditreportshouldreferto
generallyacceptedauditing
9.
(d)Therequirementistodetermine
auditorreportingresponsibility
whenpriorperiodfinancial
statementswhichreceiveda
qualifiedopinionduetoalackof
adequatedisclosurehavebeen
restatedtoeliminatethelackof
disclosure.Answer(d)iscorrect
becauseAU508statesthatan
auditorshouldexpressan
unqualifiedopinionontherestated
financialstatementsoftheprior
year(withanexplanatoryparagraph
describingthecircumstance).
Answer(a)isincorrectbecausethe
auditorsoriginalreportisnot
reissued.Answer(b)isincorrect
becausethequalifiedopinionis
eliminated.Answer(c)isincorrect
becausereferencetothetypeof
opinionexpressedisincludedinthe
reissuedreportsexplanatory
paragraph.
10. (b)Therequirementisto
identifythecorrectstate
mentconcerningan
auditorsresponsibilityto
expressanopiniononthe
financialstatements.
Answer(b)iscorrect
becausetheopening
(introductory)paragraph
oftheauditorsstandard
reportstatesthatthe
auditorsresponsibilityis
toexpressanopinionon
thefinancialstatements
basedontheaudit.
Answer(a)isincorrect
becauseoftheexplicit
statementinthe
introductoryparagraph.
Answers(c)and
(d) are incorrect because the
introductoryparagraph,notthe
scopeoropinionparagraphs,
includesthestatementonthe
auditorsresponsibility.
11.(d)Therequirementisto
determinewhetherthetermswhen
readinconjunctionwithNoteX,
andwiththeforegoing
explanationshouldbeincludedin
theopinionparagraphofaqualified
opinion.AU508statesthatanau
ditreportwithaqualifiedopinion
shouldnotincludeeitherphrasein
theopinionparagraph.
12. (d)Therequirementisto
determine
the
representations made
explicitly and implicitly
when issuing the stan
dard auditors report on
comparative financial
statements.
Answer(d)iscorrectbecausethe
standardauditreportexplicitly
statesthattheexaminationof
evidenceismadeonatestbasis
andimplicitlyassumesconsistent
applicationofaccounting
principles.Answer(a)isincorrect
becauseconsistencyofapplication
ofaccountingprinciplesisnotindi
catedexplicitly.Answer(b)is
incorrectbecauseexaminationof
evidenceonatestbasisisreferred
toexplicitly.Answer(c)is
incorrectbecauseexaminationof
evidenceonatestbasisisexplicitly
referredtoandbecauseconsistent
applicationofaccountingprinciples
isnotexplicitlyreferredto.
thefinancialstatements
(e.g.,ifthecountofthe
beginninginventoryhas
notbeenobserved,an
auditormaydisclaiman
opinionontheincome
statementandyetexpress
anunqualifiedopinionon
thebalancesheet).Answer
(b)isincorrectbecausethe
objectivedoesnotrelate
directlytoscopelimi
tations.Answer(d)is
incorrectbecausean
auditormayreportononly
onestatement.
14. (a)Therequirementisto
determinethemeaning
oftheexpressiontaken
asawholeinthefourth
generallyaccepted
auditingstandardof
reporting.AU508states
thattakenasawhole
appliesequallytoa
completesetoffinancial
statementsandtoan
individualfinancial
statement.
15. (a)Therequirementisto
determinetheappropriate
dateforanauditreport
whenasubsequentevent
requiringadjustmentof
financialstatements,
withoutdisclosureofthe
event,comestothe
auditorsattention.AU
530statesthatthedateof
completionoffieldwork
shouldbeusedinsuch
circumstances.
13. (c)Therequirementisto
determinetheobjectiveof
thefourthreporting
16. (c)Therequirementistodetermine
standardwhichrequires
anauditorsresponsibilityfor
eitheranopinion
subsequenteventswhenanaudit
regardingthefinancial
reporthasbeendualdatedfora
statementstakenasa
subsequentevent.Answer(c)iscor
wholeoranassertionto
rectbecause,whendualdatingis
theeffectthatanopinion
used,auditorresponsibilityfor
cannotbeexpressed.
eventssubsequenttothecompletion
Answer(c)iscorrect
offieldworkislimitedtothe
becausethestandard
specificeventreferredtointhe
statesthattheobjectiveis
notestothefinancialstatement.
toprevent
Answers(a),(b),and(d)areall
misinterpretationofthe
incorrectbecausetheyestablish
degreeofresponsibility
moreresponsibilitythanrequiredby
thattheauditoris
theprofessionalstandards.Note,
assumingwhenhis/her
however,thatiftheauditorchooses
nameisassociatedwith
todatethereportasofthedateof
financialstatements.
thesubsequentevent,his/her
Answer(a)isincorrect
responsibilityforothersubsequent
becausedifferingopinions
eventsextendstothedateofthe
maybeissuedoneachof
auditreport.
MODULE5REPORTING
A.3. FinancialStatementAudit
ReportsIssuer
(Public)Companies
17. (a)Therequirementistodetermine
theaccountingprinciplesthatan
issuer(public)companyauditreport
refersto.Answer(a)iscorrect
becausethefinancialstatements
followgenerallyaccepted
accountingprinciples.Answer(b)is
incorrectbecause,whiletheauditis
performedinaccordancewith
PCAOBstandards,thefinancial
statementsdonotfollowthose
standards.Answer(c)isincorrect
becausethefinancialstatementsdo
notfollowgenerallyaccepted
auditingstandards.Answer(d)is
incorrectbecausethefinancial
statementsordinarilyfollow
generallyacceptedaccounting
principles,notInternational
AccountingStandards.
185
(3)reviewingtheworkingpapers
oftheotherauditor,and(4)
performingadditionalaudit
procedures.Answer(a)isincorrect
becausenoexplanatoryparagraph
isaddedtotheauditreport.Answer
(b)isincorrectbecausetheprincipal
auditorisassumingresponsibility
fortheotherauditorsworkwhena
decisionismadenottorefertothe
otherauditorsreport.Answer(c)is
incorrectbecausewritten
permissionisnotrequiredwhenthe
principalauditoristaking
responsibilityfortheworkofthe
otherauditor.
20. (a)Therequirementisto
determinethemeaningof
sentencesaddedtoan
introductoryparagraphof
anauditorsreportthat
statesthatanotherauditor
auditedaportionofthe
entity.Answer(a)is
correctbecauseAU508
providesthatsucha
statementindicatesa
divisionofresponsibility.
Answer(b)isincorrect
becausewhentheother
auditorisreferredtothe
CPA,theCPAisnot
assumingresponsibility
fortheotherauditor.
Answer(c)isincorrect
becauseanunqualified
opinionmaybeissued.
Answer(d)isincorrect
becausethesentencesare
proper.
18. (c)Therequirementistoidentify
theincorrectstatementconcerning
informationincludedinanaudit
reportoffinancialstatementsissued
undertherequirementsofthe
PCAOB.Answer(c)iscorrectsince
thereportshouldrefertothe
auditorsreportoninternalcontrol,
notoncompliancewithlawsand
regulations.Answer(a)isincorrect
becausethereportshouldinclude
thetitleReportofIndependent
RegisteredPublicAccounting
Firm.Answer(b)isincorrect
becausethereportshouldreferto
21. (b)Therequirementistodetermine
thestandardsofthePCAOB.
thesituationinwhichanauditor
Answer(d)isincorrectbecausethe
wouldordinarilyissueanunqualified
reportshouldcontainthecityand
auditopinionwithoutanexplanatory
stateorcountryoftheofficethat
paragraph.Answer(b)iscorrect
issuedthereport.
B.1.a.OpinionBased,in
Part,onReportof
AnotherAuditor
19.(d)Therequirementisto
determineaprincipalauditors
responsibility,inadditiontomaking
inquiriesoftheotherauditors
reputationandindependence,after
havingdecidednottorefertothe
auditoftheotherauditor.Answer
(d)iscorrectbecausewhena
decisionismadenottomake
referencetotheotherauditthatis,
totakeresponsibilityforthat
auditorsworktheprincipal
auditorshouldconsider(1)visiting
theotherauditor,(2)reviewingthe
auditprogramsoftheotherauditor,
becausewhenanauditormakes
referencetothereportofanother
auditor,eachofthethreestandard
paragraphsofthereportaremodified,
butnoadditionalparagraphis
addedtothereport.Answer(a)is
incorrectbecauseemphasizingthat
theentityhadsignificantrelated
partytransactionsisnormally
accomplishedthroughtheaddition
ofanexplanatoryparagraph.
Answer(c)isincorrectbecausethe
omissionofastatementofcash
flowswhenanentityissues
financialstatementsthatpresent
financialpositionandresultof
operationsresultsinaqualified
auditopinionwithanexplanatory
paragraph.Answer(d)isincorrect
becausesubstantialdoubtaboutthe
entitysabilitytocontinueasa
goingconcernnormallyresultsin
eitheranunqualifiedopinionwith
anexplanatoryparagraphora
disclaimerofopinion.
22. (d)Therequirementisto
identifythesituationin
whichanauditormayissue
thestandardauditreport.
Answer(d)iscorrect
becauseastandardreport
maybeissuedin
circumstancesinwhichthe
principalauditorassumes
responsibilityforthework
ofanotherauditor.Answer
(a)isincorrectbecausethe
standardreportdoesnot
includereferencetoa
specialist.Thus,reference
toaspecialistwithina
reportbydefinitioncauses
modificationofthe
standardreport.Answer
(b)isincorrectbecausethe
auditorisrequiredtoissue
amodifiedreporton
condensedfinancial
statementsperAU552.
Answer(c)isincorrect
becauseauditreportson
financialstatements
preparedona
comprehensivebasisother
thanGAAPareconsidered
tobespecialreports
whichrequiredepartures
fromthestandardform.
23. (d)Therequirementistodetermine
aprincipalauditorsreporting
responsibilitywhenadecisionhas
beenmadetonotmakereferenceto
anotherCPAwhohasauditeda
clientssubsidiary.Answer(d)is
correctbecause,regardlessof
whethertheotherauditorisreferred
to,theprincipalauditormustbe
satisfiedastotheindependenceand
professionalreputationoftheother
CPA.Answer(a)isincorrect
becausetheprincipalauditorneed
notissueanunqualifiedopinionon
theconsolidatedfinancial
statements.An
swer(b)isincorrectbecauseitis
notnecessarythattheotherCPA
issueanunqualifiedopiniononthe
subsidiarysfinancialstatements.
Answer(c)isincorrectbecausethe
principalauditorshouldconsider
reviewingtheauditprogramsand
workingpapersoftheotherCPA
whenadecisionismadetonot
makereferencetothatCPA.
B.1.b.UnusualCircumstances
RequiringaDeparture
fromPromulgated
GAAP
24.(a)Therequirementisto
determinethetypeofopiniontobe
issuedwhenfinancialstatementsof
anentitythatfollowsGASB
standardsincludeajustified
departurefromGAAP.Answer(a)
iscorrectbecausetheauditor
shouldissueanunqualifiedopinion
andshouldincludeaseparate
explanatoryparagraphexplaining
thedeparturefromGAAP.Answers
(b),(c),and(d)areincorrect
becausewhentheauditorbelieves
thatthedepartureisjustified,
neitheraqualifiednoradverse
opinionisappropriate.
B.1.c.SubstantialDoubt
aboutAbilityto
RemainaGoing
Concern
25.(c)Therequirementisto
determinewhethertheterm
reasonableperiodoftime,notto
exceedoneyearand/orgoing
concernisincludedinan
explanatoryparagraphrelatingto
goingconcernstatus.Answer(c)is
correctbecausewhiletheterm
goingconcernmustbeincluded,
thefirsttermisnotincludedinsuch
areport.
186
MODULE5REPORTING
reportingresponsibility
whenthereissubstantial
doubtaboutaclients
abilitytocontinueasa
goingconcern.Answer
(a)iscorrectbecausethe
auditreportmustinclude
anexplanatoryparagraph
followingtheopinion
paragraph,andmustuse
thetermsgoingconcern
andsubstantialdoubt.
26. (a)Therequirementisto
determineanauditors
reportingresponsibility
whenreportingon
comparativefinancial
statementsinwhichthe
firstyearpresentedorigi
nallyreceivedagoing
concernmodificationona
matterthathasnowbeen
resolved,thusremoving
theauditorssubstantial 29. (b)Therequirementistoidentify
thesituationinwhichan
doubt.Answer(a)is
explanatoryparagraphmaybe
correctbecauseif
addedtoanunqualifiedreport.
substantialdoubthasbeen
Answer(b)iscorrectbecause
removedinthecurrent
substantialdoubtabouttheentitys
period,theexplanatory
abilitytocontinueasagoingcon
paragraphincludedinthe
cernleadstoeitheranunqualified
auditorsreportonthe
reportwithanexplanatory
financialstatementsofthe
paragraphoradisclaimerof
priorperiodshouldnotbe
opinion.Answer(a)isincorrect
repeated.Answers(b),
becauseanauditormayissuean
(c),and(d)areall
opiniononabalancesheetwithout
incorrectbecausethey
reportingontheotherbasic
suggesttheneedforan
financialstatements.Answer(c)is
explanatoryparagraph.
incorrectbecauseunreasonableesti
27. (b)Therequirementisto
matesleadtoeitheraqualifiedoran
adverseopinion.Answer(d)is
determinetheauditors
incorrectbecauseinadequate
responsibilitywhens/he
managementrecordretention
concludesthatthereis
policiesareascopelimitationthat
substantialdoubtaboutan
mayresultinaqualifiedopinionor
entitysabilitytocontinue
adisclaimer.
asagoingconcernfora
reasonableperiodoftime.
30. (c)Therequirementistoidentify
Answer(b)iscorrect
themanagementplananauditor
becausewhentheauditor
wouldmostlikelypositively
concludesthereis
considerwhenaquestion
substantialdoubt,s/he
concerninganentitysabilityto
shouldconsiderthe
continueasagoingconcernexists.
possibleeffectsonthe
Answer(c)iscorrectbecause
financialstatements,and
increasingtheownershipequitywill
theadequacyofthe
bringinfundstopossiblyovercome
relateddisclosures.
thenegativetrendsandfinancial
Answer(a)isincorrect
difficulties.Answers(a),(b),and
becauseeitheran
(d)areallincorrectbecause
unqualifiedopinionwith
increasingdividenddistributions,
anexplanatoryparagraph
reducinglinesofcredit,and
oradisclaimerisgener
purchasingassetswillallusefunds,
allyappropriate,nota
theywillnotprovidefunds.SeeAU
qualifiedoradverse
341forguidanceonanauditors
opinion.Answer(c)is
considerationofanentitysability
incorrectbecausethe
tocontinueasagoingconcern.
substantialdoubtofgoing
concernstatusdoesnot
31. (b)Therequirementisto
requireadjusting
identifytheconditionor
accountingestimates.
eventmostlikelytocause
Answer(d)isincorrect
anauditortohave
becausetheprioryears
substantialdoubtaboutan
auditreportneednotbe
entitysabilitytocontinue
reissuedwithan
asagoingconcern.
explanatoryparagraph.
Answer(b)iscorrect
becausedenialofusual
28. (a)Therequirementisto
tradefromsuppliersis
determineanauditors
ordinarilyanindicatorthat
thecompanyisinweak
financialcondition.
Answer(a)isincorrect
because
whilesuchrelatedpartytransactions
maybeconsideredrisky,thereis
lesslikelytobeaquestion
concerninggoingconcernstatus
thansuggestedbyanswer(a).
Answer(c)isincorrectbecausethe
paymentofsuchstockdividends
doesnotindicatefinancial
weakness.Answer(d)isincorrect
becauserestrictionsonthedisposal
ofprincipalassetsisacondition
oftenpresentinvariousloan
agreements.
32. (d)Therequirementistoidentify
themostlikelymitigatingfactora
CPAwouldconsiderwhena
clientsabilitytocontinueasa
goingconcernisinquestion.An
swer(d)iscorrectbecausethe
abilitytopostponeexpendituresfor
researchanddevelopmentprojects
maymitigatethecircumstance.See
AU341forthisandother
mitigatingfactors.Answer(a)is
incorrectbecausethereisno
guaranteethatZerosdiscussions
withitslenderswillleadtoa
restructuringofthedebtandloan
agreements.Onlyexistingor
committeeagreementstorestructure
thedebtwouldbeconsidereda
mitigatingfactor.Answer(b)is
incorrectbecauseweakinternal
controlovercashdisbursements
mayormaynothavecausedthe
goingconcernproblem.An
swer (c) is incorrect because an
entity with a going concern
problemisunlikelytobeableto
purchase such production
facilities.
33. (a)Therequirementistoidentify
theconditionoreventthatismost
likelytocauseanauditortohave
substantialdoubtaboutanentitys
abilitytocontinueasagoing
concern.Answer(a)iscorrect
becauseAU341includesnegative
cashflowsasoneofitsexamplesof
suchconditionsandevents.
Answer(b)isincorrectbecause
whilethepostponementofresearch
anddevelopmentprojectsmay
sometimesbeduetoextreme
financialdifficulties,oftenitisnot.
Answers(c)and(d)areincorrect
becauseneithersignificantrelated
partytransactionsnorstock
dividendsneednotindicate
substantialdoubtaboutanentitys
abilitytocontinueasagoing
concern.SeeAU341for
informationonanauditors
considerationofanentitysability
tocontinueasagoingconcern.
34. (b)Therequirementisto
identifytheconditionor
eventthatmightindicate
toanauditorsubstantial
doubtaboutanentitys
abilitytocontinueasa
goingconcern.Answer
(b)iscorrectbecause
confirmationwithrelated
andthirdpartiesofthe
detailsofarrangementsto
provideormaintain
financialsupportisa
procedurethatwould
assistanauditorin
identifyingaquestion
concerninggoingcon
cernstatus.SeeAU341
forthisandothersuch
conditionsandevents
indicatingdoubtaboutan
entitysabilitytocon
tinueasagoingconcern.
Answer(a)isincorrect
becausethepledgingof
assetsascollateralisa
normalbusiness
transactionanditneednot
necessarilyindicatea
questionofgoingconcern
status.Answer(c)is
incorrectbecauserec
oncilingthecashbalances
withthecutoffbank
statementisanacceptable
auditprocedure,butwill
notnormallyidentifya
goingconcernquestion.
Answer(d)isincorrect
becausecomparingan
entitysdepreciationand
assetcapitalization
policieswillnotnormally
indicateaquestionof
goingconcernstatus.
35. (a)Therequirementisto
identifytheauditproce
duremostlikelytoassist
anauditorinidentifying
conditionsandeventsthat
mayindicatetherecould
besubstantialdoubtabout
anentitysabilityto
continueasagoing
concern.Answer(a)is
correctbecauseareview
ofcompliancewithterms
ofdebtandloan
agreementsmayreveal
conditionsof
MODULE5REPORTING
noncomplianceduetopoor
financialcondition.Seetheoutline
ofAU341foralistofprocedures
thatmayidentifysuchconditions
andevents.Answers(b),(c),and
(d)areallincorrectbecause,while
theymightinsomecircumstances
revealaquestionconcerningthe
companysabilitytocontinueasa
goingconcern,theyarenot
consideredtobeaseffectiveas
answer(a).
36. (d)Therequirementisto
identifythefactorwhich
aCPAwouldmostlikely
considerasmitigating
substantialdoubtabout
theabilityofanentityto
continueasagoing
concern.Answer(d)is
correctbecause
managementsabilityto
negotiatereductionsof
requireddividendswill
decreaserequiredcash
outflows,andthereby
increasethelikelihood
thattheentitywillbeable
tocontinueasagoing
concern.AU341provides
examplesofinformation
thatmightmitigatesuch
concern.Answers(a),(b),
and(c)areallincorrect
becausetheyinvolve
spendingcash,ratherthan
reducingoutflowsof
cash.
37. (c)Therequirementisto
identifythecircumstance
mostlikelytomitigatean
auditorssubstantial
doubtaboutanentitys
abilitytocontinueasa
goingconcern.Answer
(c)iscorrectbecausethe
marketableassetsthat
managementintendsto
sellmaypotentially
providethenecessary
financialresourcesto
mitigatethesubstantial
doubtabouttheentitys
abilitytocontinueasa
goingconcern.Answer
(a)isincorrectbecause
theabilitytoexpand
opera
tionsintonewproductlinesisa
suspectcircumstance,giventhe
substantialdoubtabouttheentitys
abilitytocontinueasagoing
concern.Answer(b)isincorrect
187
becauseitalsorequirescash
resourceswhichmaynotbe
available.Answer(d)isincorrect
becauseconvertingpreferredstock
tolongtermdebtwillnotgenerally
alleviateaquestionconcerningan
entitysabilitytocontinueasa
goingconcern.
B.1.d.Inconsistencyin
ApplicationofGAAP
38. (c)Therequirementistoidentify
thecircumstancesinwhichan
auditorwouldissueareportthat
omitsanyreferencetoconsistency.
Answer(c)iscorrectbecause,as
discussedinAU508,achangein
theusefullifeofassetsisachange
inestimate,andachangein
estimatedoesnotresultina
consistencymodification.Answers
(a)and(b)areincorrectbecause
theybothrepresentachangein
accountingprinciple,andachange
inaccountingprinciplerequiresa
consistencymodification.Answer
(d)isincorrectbecause
managementslackofreasonable
justificationforachangein
accountingprincipleisadeparture
fromgenerallyacceptedaccounting
principles,andthedescriptionofthe
departurewilldiscussthe
inconsistency.
39. (d)Therequirementisto
determinewhetheranun
justifiedaccounting
change,amaterial
weaknessininternal
control,orboth,would
causeanauditorto
expressanunqualified
opinionwithan
explanatoryparagraph.
An
swer(d)iscorrectbecausean
unjustifiedaccountingchangewill
resultineitheraqualifiedoran
adverseopinionandamaterial
weaknesswillordinarilyresultin
noreportmodification(seeAU
325forinformationonthe
treatmentofmaterialweaknesses);
accordingly,anunqualifiedopinion
withanexplanatoryparagraph
addedtotheauditorsreportisnot
appropriateineithercase.
40. (b)Therequirementisto
identifythecircumstance
inwhichadisclaimerof
opinionisnot
appropriate.Answer(b)
iscorrectbecausewhen
managementdoesnot
pro
videreasonablejustificationofa
changeinaccountingprinciples
eitheraqualifiedoranadverse
opinionisappropriate,nota
disclaimer.Answers(a),(c),and
(d)areallincorrectbecausethey
representscopelimitationsthat
leadtoeitheraqualifiedopinionor
adisclaimerofopinion.
41. (a)Therequirementisto
determinetheeffectonan
auditreportofaclients
decisiontousediffering
inventorycostingmethods
forvariousportionsofits
inventory.Answer(a)is
correctbecauseastandard
unqualifiedopinionmay
ordinarilybeissued(see
AU420foradiscussion
oftheconsistency
standard).Answer(b)is
incorrectbecausethereis
nolackofconsistency
betweenaccounting
periods.Answer(c)is
incorrectbecausethereis
nodeparturefromGAAP.
Answer(d)isincorrect
becauseadverseopinions
areonlyissuedwhena
departurefromGAAP
existsthatmakesthe
financialstatements
misleading.
42. (b)Therequirementisto
identifyanauditorsre
portingresponsibilitywhen
performingafirstauditofa
newclientandwhenthe
auditorwasabletoextend
auditingproceduresto
gathersufficientevidence
aboutconsistency.Answer
(b)iscorrectbecause,when
theauditorhasobtained
assuranceastothe
consistencyofapplication
ofaccountingprinciples
betweenthecurrentand
precedingyear,nomention
ofconsistencyisincluded
intheauditreport.An
swer(a)isincorrectbecausethe
auditormayreportontheclients
incomestatement.Answer(c)is
incorrectbecausetheconsistency
standarddoesapply.Answer(d)is
incorrectbecausetheauditordoes
notrefertoconsistencywhenac
countingprincipleshavebeen
appliedconsistently.
43. (b)Therequirementistodetermine
auditorreportingresponsibility
whenmanagementdoesnotprovide
reasonablejustificationfora
changeinaccountingprincipleand
presentscomparativefinancial
statements.Answer(b)iscorrect
becausetheauditorshouldcontinue
toexpresshis/herexceptionwith
thefinancialstatementsfortheyear
ofchangeaslongastheyare
presentedandreportedon.Answer
(a)isincorrectbecausetheauditor
mustexpresshis/herexceptionfor
aslongasthefinancialstatements
fortheyearofchangearepresented
andreportedon.An
swer(c)isincorrectbecausethe
auditorneednotqualifythereport
untilmanagementchangesbackto
theaccountingprincipleformerly
used.Answer(d)isincorrect
becausethequalificationis
necessarydespitethefactthatthe
principleisgenerallyaccepted.
44. (d)Therequirementisto
determinetheinformation
thatmustbepresented
whenaclienthaschanged
accountingprinciples.
Answer(d)iscorrect
becauseinadditionto
identifyingthenatureofthe
change,theauditormust
refertothefinancial
statementnotethat
discussesthechangein
detail.Answer(a)is
incorrectbecausewhilethe
auditormustbelievethat
thechangeisjustified,itis
notnecessarytoexplainit
inthereport.Answer(b)is
incorrectbecausethe
cumulativeeffectofthe
changeneednotbe
describedintheaudit
report.Answer(c)is
incorrectbecausethe
auditorneednotmake
explicitconcurrencewith
thechange.
45. (c)Therequirementisto
determinetheproperre
portingoptionforachange
inaccountingprinciples
withanimmaterialcurrent
yeareffect,butwhichis
expectedtohavea
substantialeffectin
subsequentyears.Answer
(c)iscorrectbecausethe
auditorneednotrecognize
thechangeintheaudit
reportandmayissuea
standardunqualified
opinion.
188
B.1.e. CertainCircumstances
AffectingComparative
FinancialStatements
MODULE5REPORTING
management,the
successorauditor,orboth,
beforereissuingtheprior
yearsauditrecord.
Answer(a)iscorrect
becausethepredecessor
auditorshouldobtaina
representationletterfrom
bothmanagement(AU
333)andthesuccessor
auditor(AU508).
46. (a)Therequirementistoidentify
thecircumstanceinwhichan
auditorreportingoncomparative
financialstatementswould
ordinarilychangethepreviously
issuedopinionontheprioryears
financialstatements.Answer(a)is 49. (d)Therequirementistoidentify
thecircumstanceinwhicha
correctbecausewhenanauditorhas
standardunqualifiedreportmaybe
previouslyexpressedaqualifiedor
issuedwhensingleyearfinancial
anadverseopiniononfinancial
statementsarepresented.Answer
statementsofapriorperiodand
(d)iscorrectbecausewhentheprior
thosefinancialstatementshavebeen
yearsfinancialstatementsarenot
restated,theauditorsupdated
beingpresented,theCPAneednot
reportischanged.Answer(b)is
refertothemorincludethe
incorrectbecause,ordinarily,the
predecessorauditorsreport.See
reissuedreportbyapredecessor
AU508forinformationon
auditorwillbethesameasthat
reissuanceofapredecessorsreport
originallyissued.Answer(c)is
whencomparativefinancial
incorrectbecausetheprioryears
statementsarebeingissued.An
opinionwillremainunqualifiedif
swer(a)isincorrectbecause
thecurrentyearsauditreportis
inabilitytoauditaninvestmentina
modifiedduetoalackof
foreignaffiliateisascopelimitation
consistency.Answer(d)isin
thatislikelytoresultineithera
correctbecauserestatementofprior
qualifiedopinionoradisclaimer.
yearsfinancialstatements
An
followingapoolingofinterestwill
swer(b)isincorrectbecausea
notleadtoachangeinthe
qualifiedopinionisappropriate
previouslyissuedopinion.
whenanentitydeclinestopresenta
47. (d)Therequirementisto
statementofcashflowswithits
balancesheetandrelatedstatements
determinetheinformation
ofincomeandretainedearnings.
tobeincludedinanaudit
Answer(c)isincorrectbecausethe
reportoncomparative
emphasisofanaccountingmatter
financialstatementswhen
byanauditorresultsininclusionof
apredecessorauditors
anexplanatoryparagraphtothe
reportisnotbeing
unqualifiedauditreport.
reissued.Answer(d)is
correctbecausethe
50. (a)Therequirementisto
introductoryparagraphof
identifythecorrectform
thesuccessorsreport
ofanauditreporton
shouldindicate(1)that
comparativefinancial
thefinancialstatements
statementswhena
ofthepriorperiodwere
continuingauditorhas
auditedbyanother
auditedthetwoyearsof
auditor(whosenameis
financialstatements
notpresented),(2)the
beingpresented.Answer
dateofthepredecessors
(a)iscorrectbecauseone
report,(3)thetypeof
auditreportshouldbe
reportissuedbythe
issuedthatincludesthe
predecessor,and(4)ifthe
yearsinvolved.Answer
reportwasotherthana
(b)isincorrectbecause
standardreport,the
onereport,nottwo
substantivereasons
reports,shouldbeissued.
therefor.
Answer(c)isincorrect
becausebothyears
48. (a)Therequirementisto
shouldbereportedupon.
determinewhetherthe
Answer(d)is
predecessorauditor
shouldobtaina
representationletterfrom
incorrectbecauseauditorsdonot
havetheoptionofissuingtwo
auditreportsinthiscircumstance.
51. (d)Therequirementisto
determinethemannerin
whichapredecessor
auditorwhohasreissued
areportforcomparative
financialstatements
shouldrefertothe
successorauditor.AU
508indicatesthatthe
predecessorauditor
shouldnotreferinthe
reissuedreporttothe
reportorworkofthe
successorauditor.
52. (d)Therequirementisto
determinetheproperre
portingprocedurefor
comparativefinancial
statementsforwhichthe
prioryearisunaudited,and
thecurrentyearisaudited.
AU504statesthatwhen
unauditedfinancialstate
mentsarepresentedin
comparativeformwith
auditedfinancial
statements,thereporton
thepriorperiodmaybe
reissuedtoaccompanythe
currentperiodreport.In
addition,thereportonthe
currentperiodmayinclude
aseparateparagraph
describingresponsibility
assumedfortheprior
periodfinancialstatements.
Ifthesestatementsarefiled
withtheSEC,the
statementsshouldbe
clearlymarkedasun
auditedbutshouldnotbe
referredtointheauditors
report.
B.1.g. RequiredSupplementary
Information
53. (c)Therequirementisto
identifyanauditorsre
sponsibilityforrequired
supplementary
informationthatisplaced
outsidethebasicfinancial
statements.Answer(c)is
correctbecauseAU558
requiresthattheauditor
applylimitedprocedures
totheinformationand
reportdeficienciesin,or
theomissionof,the
information.Answer(a)
isincorrectbecausethe
auditordoeshavesome
responsibilityforthe
supplementary
information.Answer(b)
isincorrectbecausethe
auditormustapply
limitedproceduresto
informationpresented
andreportdeficienciesin
theinformationin
additiontodetermining
whetherithasbeen
omitted.Answer(d)is
incorrectbecausetestsof
detailsoftransactionsand
balancesneednotbe
performed.
54. (d)Therequirementisto
determinetheproperaudit
reportwhenmanagement
declinestopresent
supplementary
informationrequiredby
theGovernmental
AccountingStandards
Board.Answer(d)is
correctbecauseomission
ofrequiredsupplementary
information,whichwhen
presentedisnot
consideredaudited,leads
toanunqualifiedopinion
withanexplanatory
paragraph.Answers(a)
and(b)areincorrect
becauseneitheranadverse
opinionnoraqualified
opinionisappropriate
sincethesupplementary
informationisnotaudited.
Answer(c)isincorrect
becauseitisincomplete
sinceanunqualified
opinionwithanadditional
explanatoryparagraphis
required.
B.1.h.OtherInformation
withAudited
Financial
Statements
55.(c)Therequirementisto
identifythecorrectstatementthat
maybeincludedinanauditors
reportwhenanauditorprovidesan
opiniononinformation
accompanyingthebasicfinancial
statements.Answer(c)iscorrect
becausethereportindicateswhether
theaccompanyinginformationis
fairlystatedinallmaterialrespects
inrelationtothebasicfinancial
statementstakenasawhole.
Answer(a)isincorrectbecausethe
informationisnotpresentedin
accordancewithgenerallyaccepted
auditingstandards.Answer(b)is
incorrectbecausetheinformationis
inadditiontothatrequiredby
generallyacceptedaccounting
principles.An
MODULE5REPORTING
swer(d)isincorrectbecauseit
isnotinaccordancewith
attestationstandards.
56. (a)Therequirementistoidentify
theauditorsreporting
responsibilityforamaterial
inconsistencybetweentheaudited
financialstatementsandtheother
informationinanannualreportto
shareholderscontainingaudited
financialstatements.Answer(a)is
correctbecauseAU550statesthat
ifamaterialinconsistencyexists
andtheclientrefusestorevisethe
otherinformation,theauditor
shouldincludeanexplanatory
paragraphthatexplainsthe
inconsistency.Theauditormayalso
withholdtheuseoftheauditreport
ortheauditormaywithdrawfrom
theengagement.Answer(b)is
incorrectbecausethefinancial
statementsarenotmisstated.
Answer(c)isincorrectbecausethe
auditormustreviewtheother
informationtoensurethatitis
consistentwiththefinancial
statements.Answer(d)isincorrect
becausethefinancialstatements
arenotmisstatedandthereforea
disclaimerofopinionis
inappropriate.
57. (d)Therequirementisto
determineanauditors
responsibilitywhen
auditedfinancial
statementsarepresented
inadocumentcontaining
otherinformation.An
swer(d)iscorrectbecause
theauditorisrequiredto
readtheotherinformation
todeterminethatitis
consistentwiththe
auditedfinancial
statements.Answers(a)
and(c)areincorrect
becausenosuchinquiry,
analyticalprocedures,or
othersubstantiveauditing
proceduresarerequired.
Answer(b)isincorrect
because,unlessthe
informationseems
incorrectorinconsistent
withtheauditedfinancial
statements,noex
planatoryparagraphneeds
tobeaddedtothe
auditorsreport.
B.1.i.
EmphasisofaMatter
189
58.(d)Therequirementisto
identifytheproperstatementabout
anauditreportthatincludesa
separateparagraphinanotherwise
unmodifiedreportthatemphasizes
thattheentitybeingreportedonhad
significanttransactionswithrelated
parties.Answer(d)iscorrect
becauseAU508allowssuch
emphasisofamatterandstatesthat
itdoesnotnegatetheunqualified
opinion.Answer(a)isincorrectbe
causethereportisconsidered
unqualified.Answer(b)isincorrect
becausesuchemphasisofamatter
doesnotviolategenerallyaccepted
auditingstandardsifthis
informationisdisclosedinnotesto
thefinancialstatements.Answer(c)
isincorrectbecausethereport
shouldnotincludethephrasewith
theforegoingexplanation.
B.1.j.
DeparturesfromGAAP
59. (b)Therequirementisto
identifytheappropriate
typesofauditreportswhen
anillegalactwitha
materialeffectonthe
financialstatementshasnot
beenproperlyaccounted
forordisclosed.Answer
(b)iscorrectbecause
omissionofrequired
disclosures,adeparture
fromgenerallyaccepted
accountingprinciples,leads
toeitheraqualifiedoran
adverseopinion.Answer
(a)isincorrectbecausea
disclaimerofopinionis
notappropriatewhenthe
auditorknowsofsuch
misstatements.Answer(c)
isincorrectbecause
neitheradisclaimerof
opinionnoranunqualified
opinionwithaseparate
explanatoryparagraphis
appropriate.Answer(d)is
incorrectbecausean
unqualifiedopinionwitha
separateexplanatory
paragraphisnot
appropriate.
60. (c)Therequirementisto
identifythephrasethatan
auditor would include in
an audit report with a
qualified
opinionbecauseofinadequate
disclosure.AU508indicatesthat
thephraseexceptfortheomission
oftheinformationdiscussedinthe
opinionparagraphistheproper
phrase.Answers(a),(b),and(d)
areallincorrectbecausetheyare
phrasesnotallowedinreportswith
qualifiedopinions.
61. (c)Therequirementisto
identifythecircumstance
thatwouldmostlikely
resultinanauditor
expressinganadverse
opinion.Answer(c)is
correctbecause
departuresfromGAAP,
suchasinappropriately
reportingleases,resultin
eitheraqualifiedoran
adverseopinion.Answer
(a)isincorrectbecause
clientrefusaltoprovide
accesstominutesisa
clientimposedscope
limitationthatwill
normallyresultina
disclaimerofopinion.
Answer(b)isincorrect
becauseweakinternal
controlwillnotingeneral
resultinanadverse
opinion;ifcontrolsareso
weakthatanauditcannot
effectivelybecompleted,
adisclaimerofopinionor
withdrawalmaybe
appropriate.Answer(d)
isincorrectbecausesub
stantialdoubtaboutgoing
concernstatusresultsin
eitheranunqualified
opinionwithan
explanatoryparagraphor
adisclaimerofopinion.
62. (d)Therequirementisto
identifytheparagraphsof
anauditreportthatare
modifiedwhenanauditor
qualifiesanopinion
becauseofinadequate
disclosure.Inadditionto
requiringtheinclusionof
aseparateexplanatory
paragraph,AU508
indicatesthatonlythe
opinionparagraphshould
bemodified.
63. (b)Therequirementisto
determinetheappropriate
reportmodificationthat
resultswhenthe
managementofapublicly
heldcompanyissues
financialstatementsthat
purporttopresentits
financialpositionand
resultsofoperationsbut
omitsthestatementof
cashflows.Answer(b)is
correctbecausefailureto
includeastatementof
cashflowswillleadthe
auditortoqualifythe
opinion.
64. (b)Therequirementisto
identifythecircumstance
inwhichanauditorwill
choosebetweenexpressing
anexceptforqualified
opinionandanadverse
opinion.Answer(b)is
correctbecauseomissions
ofrequiredinformation,a
departurefromgenerally
acceptedaccountingprinci
ples,leadstoeithera
qualifiedoranadverse
opinion.Answer(a)is
incorrectbecauseascope
limitationsuchasthe
failuretoobserveaclients
physicalinventoryleadsto
eitheraqualifiedopinion
oradisclaimerofopinion.
Answer(c)isincorrect
becauseanauditormay
issueanunqualified
opinionononestatement.
Answer(d)isincorrect
becausesubstantialdoubt
aboutanentitysabilityto
continueasagoing
concernleadstoeitheran
unqualifiedreportwith
explanatorylanguageora
disclaimerofopinion.
65. (b)Therequirementistoidentify
thesituationinwhichanauditor
willordinarilychoosebetween
expressingaqualifiedopinionoran
adverseopinion.Answer(b)is
correctbecausedeparturesfrom
generallyacceptedaccounting
principlesresultineitheraqualified
opinionoranadverseopinion
suchlackofdisclosureisa
departurefromgenerallyaccepted
accountingprinciples.Answer(a)is
incorrectbecausetheinabilityto
observethephysicalinventoryand
inabilitytobecomesatisfiedabout
itsbalancerepresentsascope
limitationthatwillresultineithera
qualifiedopinionoradisclaimerof
opinion.Answer(c)isincorrect
becauseachangeinaccounting
principlesleadstoanunqualified
opinionwithanexplanatory
paragraphaddedtothereport.
Answer(d)isincorrectbecause
inabilitytoapply
MODULE5REPORTING
190
necessaryproceduresrepresentsa
scopelimitationthatwillresultin
eitheraqualifiedopinionora
disclaimerofopinion.SeeAU508
forinformationonauditreports.
B.1.k.ScopeLimitations
66. (a)Therequirementistoidentify
thetypeofopinionthatshouldbe
issuedonthefinancialstatements
whenanauditorhasbeenunableto
obtainsufficientevidencerelating
totheconsistentapplicationof
accountingprinciplesbetweenthe
currentandprioryear.Answer(a)is
correctbecausethescope
limitationwillaffecttheyears
beginningbalancesandthereby
affectthecurrentyearsresultsof
operationsandcashflows.Answer
(b)isincorrectbecausetheyearend
balancesheetwillbeunaffectedby
thescopelimitation(anyretained
earningsmisstatementofthe
precedingyearwillbeoffsetinthe
currentyear).Answer(c)isincor
rectbecausetheauditorneednot
withdrawinsuchcircumstances.
Answer(d)isincorrectbecausethis
situationrepresentsascope
limitation,andnotanuncertainty.
Answer(c)isincorrect
becauseanauditors
emphasisofanunusually
importantsubsequent
eventresultsinareport
withanunqualified
opinionwithan
explanatoryparagraph.
68. (a)Therequirementisto
determinetheproprietyof
includingastatementthat
thecurrentassetportionof
anentitysbalancesheet
wasfairlystatedinan
auditreportthatdisclaims
anopinionontheoverall
financialstatements.
Answer(a)iscorrect
becauseexpressionsof
opinionastocertain
identifieditemsin
financialstatements
(referredtoaspiecemeal
opinions)shouldnotbe
expressedwhenthe
auditorhasdisclaimedan
opinionorhasexpressed
anadverseopinion.Such
opinionstendto
overshadoworcontradict
thedisclaimeroradverse
opinion.Answer(b)is
incorrectbecausean
auditormayreportonone
basicfinancialstatement.
Answers(c)and(d)are
incorrectbecausepro
vidingsuchassuranceis
notappropriate.
67. (d)Therequirementisto
identifythecircumstance
inwhichanauditorwould
notexpressanunqualified
opinion.Answer(d)is
correctbecausean
inabilitytoobtainthe
69. (b)Therequirementistoidentify
auditedfinancial
thetypeofopinionthatshouldbe
statementsofa
issuedonthebalancesheetandthe
consolidatedinvestee
incomestatementwhenanauditor
representsascope
didnotobserveaclientstakingof
limitation,anda
thebeginningphysicalinventory
significantscopelimita
andwasunabletobecomesatisfied
tionresultsineithera
aboutitsaccuracybyusingother
qualifiedopinionora
auditingprocedures.Answer(b)is
disclaimerofopinion.
correctbecausethescopelimitation
Answer(a)isincorrect
willnotaffecttheyearendbalance
becauseamaterialchange
sheetaccountbalances.However,
betweenperiodsin
becauseevidencewithrespecttothe
accountingprincipleswill
beginninginventoryislacking,
resultinanexplanatory
verificationofcostofgoodssold,an
paragraphbeingaddedto
incomestatementelement,is
areportwithanun
impossible.Althoughyearend
qualifiedopinion.Answer
retainedearningswillnotbe
(b)isincorrectbecause
affected,boththecurrentandprior
theomissionoftheSEC
yearsretainedearningsstatements
requiredquarterly
willbeaffected(byanoffsetting
financialdata,whichis
amount)bythecostofgoodssold
consideredunaudited,
misstatement.Ifnootherproblems
resultsinareportwithan
arise,theauditorwillbe
unqualifiedopinionwith
anexplanatoryparagraph.
abletoissueanunqualifiedopinion
onthebalancesheetandadisclaimer
ontheincomestatement(andonthe
retainedearningsstatement).Answer
(a)isincorrectbecausean
unqualifiedopinionmaybeissuedon
thebalancesheet.Answer(c)is
incorrectbecauseanunqualified
opinionmaybeissuedonthebalance
sheetwithadisclaimeronthein
comestatement.Answer(d)is
incorrectbecauseadisclaimer
shouldbeissuedontheincome
statement.
70. (c)Therequirementisto
determinewhetherthe
scopeparagraph,opinion
paragraph,and/ornotesto
thefinancialstatements
shouldrefertoanaudit
scopelimitation.Answer
(c)iscorrectbecausethe
suggestedreport
presentedforascope
limitationincludes
modificationofboththe
scopeandopinion
paragraphs.Inaddition,it
isnotappropriateforthe
scopeoftheaudittobe
explainedinanotetothe
financialstatements.
71. (c)Therequirementistoidentifya
CPAsresponsibilitywhenasked
toreportononlyonefinancial
statement.Answer(c)iscorrect
becausetheauditormayacceptthe
engagementbecausethesituation
involveslimitedreporting
objectives,notalimitationonthe
scopeofauditprocedures.Answers
(a),(b),and(d)areincorrect
becausetheauditorisabletoaccept
suchanengagementandbecause
theauditorisabletoapplythe
proceduresconsiderednecessary.
72. (d)Therequirementisto
determinewhethereither
thescopeparagraph,the
opinionparagraph,or
bothshouldbedeleted
whenanauditoris
disclaiminganopinion
duetoaclientimposed
scopelimitation.Answer
(d)iscorrectbecausethe
scopeparagraphis
omittedinthissituation
andtheopinion
paragraphismodifiedto
disclaimanopinion.
Answer(a)isincorrect
becauseitsuggeststhat
thescopeparagraphis
notomittedbutthatthe
opinionparagraphis
omitted.Answer(b)is
incorrectbecauseitstates
thattheopinion
paragraphisomitted.
Answer(c)isincorrect
becauseitstatesthatthe
scopeparagraphisnot
omitted.
73. (c)Therequirementistoidentifythe
informationincludedintheopinion
paragraphofanauditorsreportthatis
qualifiedduetoamajorinadequacyin
thecomputerizedaccountingrecords.
Answer(c)iscorrectbecausethe
opinionparagraphindicatesthatthe
exceptionisduetothepossible
effectsonthefinancialstatements.
Answer(a)isincorrectbecausethe
opinionparagraphwillnotincludea
referencetoclientimposedscope
limitations.Answer(b)isincorrect
becausenoindicationofadeparture
fromgenerallyacceptedauditing
standardsisprovidedintheopinion
paragraphandthissituationisnota
departurefromGAAS.Answer(d)is
incorrectbecausethereisno
indicationthatthereisinadequate
disclosureofnecessaryinformation.
74. (d)Therequirementisto
identifythecircumstance
inwhichascope
limitationissufficientto
precludeanunqualified
opinion.Answer(d)is
correctbecauseAU333
statesthatmanagements
refusaltofurnishsucha
writtenrepresentation
constitutesalimitation
onthescopeofanaudit
sufficienttoprecludean
unqualifiedopinion.An
swers(a),(b),and(c)are
allincorrectbecause
whiletheyrepresent
scopelimitations,they
maysometimesnot
resultinareportthatis
otherthanunqualified.
B.1.l.LackofIndependence
75.(b)Therequirementisto
identifythesituationinwhichan
auditormaynotissuea
qualifiedopinion.An
MODULE5REPORTING
swer(b)iscorrectbecausethe
auditorwholacksindependence
mustdisclaimanopinion,not
qualifyanopinion.Answer(a)is
incorrectbecauseadeparturefrom
GAAPwillresultineithera
qualifiedopinionoranadverse
opinion.Answer(c)isincorrect
becausescopelimitationsresultin
eitheraqualifiedopinionora
disclaimerofopinion.Answer(d)
isincorrectbecauseaspecialistmay
bereferredtowhenanauditoris
issuingaqualifiedopinion,an
adverseopinion,oradisclaimerof
opinion.
B.2.
ReportPreparation
76. (d)Therequirementistoidentify
themannerinwhichanauditormay
expressanopiniononanentitys
accountsreceivablewhenthat
auditorhasdisclaimedanopinion
onthefinancialstatementstakenas
awhole.Answer(d)iscorrect
becausesuchareportisconsidered
aspecifiedelements,accounts,or
itemsreport,andshouldinclude
theopinionontheaccounts
receivableseparatelyfromthedis
claimerofopiniononthefinancial
statement.Answer(a)isincorrect
becausereasonforthedisclaimerof
opinionneednotbeprovided.
Answer(b)isincorrectbecause
distributionofsuchareportisnot
restrictedtointernaluseonly.
Answer(c)isincorrectbecausethe
auditorneednotreportonthe
currentassetportionoftheentitys
balancesheettoissuesuchareport.
77. (a)Therequirementistodetermine
theproperaddresseeofareportin
acircumstanceinwhichone
companyhashiredaCPAtoaudit
anothercompanysfinancialstate
ments.Answer(a)iscorrect
becausewhileauditreportsare
ordinarilyaddressedtothecompany
whosefinancialstatementsare
beingaudited,whenaCPAaudits
thefinancialstatementsofa
companythatisnothisorherclient
(asisthecasehere)thereportis
addressedtothecompanythathired
theCPA.
78. (b)Therequirementisto
identifytheinformation
thatshouldbeincluded
intheopinionparagraph
ofanauditreportwithan
adverseopinion.Answer
(b)iscorrectbecause
191
theopinionparagraph
shouldincludeadirect
referencetoaseparate
paragraphdisclosingthe
basisfortheopinion.
Answer(a)isincorrect
becausetheprincipalef
fects,ifavailable,should
bedescribedinaseparate
explanatoryparagraph,
andnotintheopinion
paragraph.Answer(c)is
incorrectbecausewhilea
separateexplanatory
paragraphprovidesa
descriptionofthe
substantivereasonsfor
theadverseopinion,the
opinionparagraphdoes
not.Answer(d)is
incorrectbecauseneither
anuncertaintynora
scopelimitationleadsto
anadverseopinion.
79. (b)Therequirementisto
determinetheproper
placementofanexplanatory
paragraphdisclosingthe
substantivereasonsfor
expressinganadverse
opinion.AU508requires
thatsuchparagraphs
precedetheopinion
paragraph.
C.1.a.UnauditedStatements
80.(b)Therequirementisto
determinetheCPAsre
sponsibilitywhens/heassistsin
preparingfinancialstatementsof
apubliclyheldentity,buthasnot
auditedorreviewedthem.Answer
(b)iscorrectbecausetheCPA
must,ataminimum,readthe
financialstatementsforobvious
materialmisstatements.Answer
(a)isincorrectbecauseno
documentationwithrespectto
internalcontrolisnecessary.
Answer(c)isincorrectbecausethe
limitedscopeofproceduresbeing
performeddoesnotallowtheCPA
toascertain
whetherthefinancialstatementsare
inconformitywithgenerally
acceptedaccountingprinciples.
Answer(d)isincorrectbecause
omittingallrequireddisclosuresis
notexpectedforapubliclyheld
entityinthesecircumstances.
81.(d)Therequirementisto
identifytheappropriateformof
reporttoissuewhentheCPAis
associatedwiththefinancial
statementsofapubliclyheldentity
buthasnotauditedorreviewed
suchstatements.Answer(d)is
correctbecausethestandards
requiretheCPAtodisclaiman
opiniononthefinancialstatements
whentheaccountanthasnotaudited
orreviewedsuchstatements.
Answer(a)isincorrectbecause
RegulationSXexemptionisnota
formofauditreport.Answer(b)is
incorrectbecauseproforma
informationisnotinvolved.
Answer(c)isincorrectbecause
thereisnosuchreportasan
unauditedassociationreport.
82.(d)Therequirementisto
identifyaCPAsresponsibility
whenhis/hernameistobe
includedintheinterimreportofa
publiclyheldentityandtheCPA
hasnotauditedorreviewedthe
interimfinancialstatements.
Answer(d)iscorrectbecausewhen
anaccountantisawarethathis/her
nameistobeincludedinaclient
preparedwrittencommunication
ofapublicentitycontaining
financialstatementsthathavenot
beenauditedorreviewed,he/she
shouldrequest(1)thathis/her
namenotbeincludedinthe
communicationor(2)thatthe
statementsbemarkedasunaudited
andnotethatthereisnoopinion
expressedonthem.
C.1.c.ReviewedInterim
(Quarterly)Statements
83. (a)Therequirementistoidentify
theobjectiveofareviewofinterim
financialinformation.Answer(a)is
correctbecauseAU722statesthat
theobjectiveofareviewofinterim
financialinformationistoprovidea
basisforreportingonwhether
materialmodificationshouldbe
madeforsuchinformationto
conformwithgenerallyaccepted
accountingprinciples.Answer(b)
isincorrectbecausenoupdated
opinionisbeingissued.Answer(c)
isincorrectbecausecondensed
statementsorproformafinancial
informationarenotbeing
consideredinthisquestion.An
swer(d)isincorrectbecausethe
statementsmayormaynotbe
presentedinconformitywith
generallyacceptedaccounting
principles.
84. (a)Therequirementisto
identifythecorrectstate
mentwithrespecttoan
independentaccountants
reviewreportoninterim
financialinformation
presentedinaregistration
statement.Answer(a)is
correctbecausean
accountantsreview
reportisnotapartofthe
registrationstatement
withinthemeaningof
Section11ofthe
SecuritiesActof1933.
Answer(b)isincorrect
becauseundercertain
conditionsanaccountant
isrequiredtoupdatethe
report.Answers(c)and
(d)areincorrectbecause
theprospectusincludes
neitherastatementthat
thereviewwasperformed
inaccordancewithSEC
standards,norastatement
thattheaccountant
obtainedcorroborating
evidence.
85. (d)Therequirementisto
determinethecircum
stanceswhichwillleadto
amodificationofan
interimreport.Departures
fromgenerallyaccepted
accountingprinciples,
whichincludeadequate
disclosure,require
modificationofthe
accountantsreport.
Normallyneitheran
uncertainty[answer(a)]
noralackofconsistency
[answer(b)]wouldcause
areportmodification.
Referencetoanother
accountant[answer(c)]is
notconsidereda
modification.
192
MODULE5REPORTING
reviewislessinscope
thananaudit,notthana
compilation.
86. (b)Therequirementistoidentify
theprocedurethatwouldordinarily
C.1.d.CondensedFinancial
beappliedwhenanaccountant
Statements
conductsareviewoftheinterim
financialinformationofapublicly
89. (c)Therequirementistodetermine
heldentity.Answer(b)iscorrect
thecircumstanceunderwhichan
becausetheaccountantwill
auditormayreportoncondensed
ordinarilyreadtheminutesof
financialstatementsthatarederived
meetingsofstockholders,theboard
fromcompleteauditedfinancial
ofdirectors,andcommitteesofthe
statements.Answer(c)iscorrect
boardofdirectorstoidentifyactions
becauseareportmaybeissued
thatmayaffecttheinterimfinancial
whentheinformationinthe
information.AU722describesthe
condensedfinancialstatementsis
natureofproceduresforconducting
fairlystatedinallmaterialrespects
areviewofinterimfinancial
inrelationtothefinancial
information.Answers(a),(c),and
statements.Answer(a)isincorrect
(d)areallincorrectbecausethey
becausethecondensedfinancial
representverificationprocedures
statementsneednotbedistributed
typicallybeyondthescopeofare
withthecompletefinancial
viewofinterimfinancial
statements.Answer(b)isincorrect
information.
becausethereportneednotindicate
thenatureofanyadditional
87. (c)Therequirementisto
procedures.Answer(d)isincorrect
identifytheleastlikely
becauseprioryearcondensed
proceduretobeincluded
financialinformationisnot
inanaccountantsreview
necessary.SeeAU552for
ofinterimfinancial
informationoncondensedfinancial
informationofanissuer
statements.
(public)entity.Answer
(c)iscorrectbecausea
90. (a)Therequirementistodetermine
reviewconsists
theappropriateresponserelatingto
principallyofperforming
selectedfinancialdatathatare
analyticalproceduresand
includedinaclientsprepared
makinginquiries,not
documentcontainingaudited
proceduressuchas
financialstatements.Answer(a)is
observation,inspection,
correctbecausetheselecteddata
andconfirmation.
shouldbelimitedtodataderived
Answers(a),(b),and(d)
fromtheauditedfinancial
areallincorrectbecause
statements.Answer(b)isincorrect
theyincludereview
becausedistributionofthereport
procedures,aspresented
neednotbelimitedtosenior
inAU722.
managementandtheboardof
directors.Answer(c)isincorrect
88. (c)Therequirementisto
becausetheselecteddataneednot
identifythemostlikely
followacomprehensivebasisofac
informationincludedina
countingotherthanGAAP.Answer
reviewreport.Answer
(d)isincorrectbecausethereport
(c)iscorrectbecause
willordinarilystatethattheselected
AU722requiresthatthe
dataarefairlystatedinallmaterial
reportincludeade
respectsinrelationtothe
scriptionofprocedures
consolidatedfinancialstatements.
performed.Answer(a)is
incorrectbecausethe
informationwas
reviewed,notexamined,
inaccordancewith
standardsofthePCAOB.
Answer(b)isincorrect
becausetheinterim
financialinformationis
theresponsibilityofthe
entitysmanagement,not
theshareholders.Answer
(d)isincorrectbecausea
C.1.e.FinancialStatements
PreparedforUsein
OtherCountries
91. (a)Therequirementisto
identifyauditreporting
requirementswhen
reportingonfinancial
statementsofaUSentity
preparedinaccordance
withanothercountrysac
countingprinciples.
Answer(a)iscorrect
becauseAU534states
thattheauditorshould
understandtheaccounting
principlesgenerally
acceptedintheother
country.Answer(b)is
incorrectbecausethe
auditordoesnothaveto
obtaincertificationoutside
oftheUnitedStates.
Answer(c)isincorrect
becausetheauditordoes
nothavetodisclaiman
opinion.Answer(d)is
incorrectbecausethe
auditordoesnothaveto
receiveawaiverfromthe
auditorsStateBoardof
Accountancy.
92. (d)Therequirementisto
determinetheappropriate
typesofreportsthatmay
beissuedwhenthe
financialstatementsofa
USsubsidiaryare
preparedfollowingthe
principlesofanonUS
parentcompanyscountry
forinclusioninthatparent
companysnonUS
consolidatedfinancial
statements.AU534
allowseitheramodified
USstylereportorthe
reportformoftheparents
country.AUSstyle
unmodifiedreportisnot
appropriate.
C.2.a.SpecialReports
becausethefinancialstatements
neednotbepreparedinconformity
withGAAP,asotherbasesof
accountingmaybefollowed.
Answer(c)isincorrectbecausethe
reportneednotbemadeavailable
fordistributiontootheremployees.
Answer(d)isincorrectbecausethe
individualintheprofitparticipation
planneednotownacontrolling
interestinthecompany.
94. (d)Therequirementisto
determinetheinformation
thatshouldbeincludedin
an audit report on
financial statements
prepared on the income
tax basis of accounting.
AU
623 presentstheformofthe
reporttobeissued.
Answer(d)iscorrect
becauseAU623requires
thatthereportindicate
thattheincometaxbasis
ofaccountingisa
comprehensivebasisof
accountingotherthan
GAAP.
95. (d)Therequirementisto
identifytheappropriate
typeofauditreporttobe
issuedforanonprofit
entitysfinancial
statementsprepared
followinganaccounting
basisprescribedbya
regulatoryagencysolelyfor
filingwiththatagency.
Answer(d)iscorrect
becauseauditreportsfor
suchfinancialstatements
areconsideredspecial
reports.Answer(a)is
incorrectbecausean
unqualifiedreportmaybe
issuedifthereareno
departuresfromthe
prescribedbasis.Thereport
wouldnotbequalified
becausethefinancial
statementswereprepared
usinganaccountingbasis
prescribedbyaregulatory
agency.Answer(b)is
incorrectbecausethe
reportissuedhasfive
paragraphs.Answer(c)is
incorrectbecausea
disclaimerofopinionneed
notbeissued.
93. (a)Therequirementistoidentifya
requirementforaCPAtoexpressan
opiniononaprofitparticipation
planrelatingtoanentitysnet
income.Answer(a)iscorrect
becauseifaspecifiedelementis,or
isbasedupon,anentitysnet
incomeorstockholdersequity,the
CPAshouldhaveauditedthe
96. (c)Therequirementistoidentifythe
completefinancialstatementsin
disclosureincludedinaseparate
ordertoexpressanopiniononthe
explanatoryparagraphofanauditors
element.Answer(b)isincorrect
specialreportonfinancialstatements
MODULE5REPORTING
withthecashbasisofaccounting.
Answer(c)iscorrectbecausethe
explanatoryparagraphreferstothe
notetothefinancialstatementsthat
describesthebasisofaccounting.
AU623presentscompletedetails
onsuchspecialreports.Answer(a)
isincorrectbecausethereportneed
notjustifythereasonsfor
followingabasisotherthan
generallyacceptedaccounting
principles.Answer(b)isincorrect
becausetheexplanatoryparagraph
containsnostatementonfair
presentation,andbecausethe
opinionparagraphstateswhether
thepresentationisinconformity
withthebasisdescribedinthe
appropriatefinancialstatement
note.Answer(d)isincorrect
becausenoexplanationofhowthe
resultsofoperationsdifferfrom
financialstatementspreparedin
conformitywithgenerallyaccepted
accountingprinciplesisnecessary.
97. (b)Therequirementisto
identifytheexampleofa
specialreport.AU623
definesreportson
compliancewithaspects
ofregulatory
requirementsrelatedto
auditedfinancial
statementsasspecial
reports.[Theothertypes
ofspecialreportsinclude
(1)othercomprehensive
basisfinancial
statements,(2)specified
elements,(3)financial
presentationstocomply
withcontracts,and(4)
financialinformation
presentedinprescribed
forms.]
98. (a)Therequirementisto
determinethetypeofre
porttoissuewhenaclient
whousesacomprehensive
basisofaccountinghas
notappropriatelytitledits
financialstatements.
Answer(a)iscorrect
becauseanysuch
exceptionsorreservation
shouldbedescribedinan
explanatoryparagraphand
possiblyaqualified(or
adverse)opinionshould
beissued.Answer(b)is
incorrectbecausenosuch
applicationtothestate
preparedinconformity
193
insurancecommissionis
necessary.Answer(c)is
incorrectbecausea
disclaimerofopinionis
notappropriatewhen
knownmisstatements
exist.Answer(d)is
incorrectbecause,as
indicated,morethan
describingthe
terminologyisnecessary.
99. (a)Therequirementisto
determinewhetheraCPA
is permitted to accept an
engagementtoauditeither
a schedule of accounts
receivable, a schedule of
royalties,orboth.
Answer(a)iscorrectbecause
auditorsmayauditspecified
elements,accountsoritemsofa
financialstatement,including
eitherascheduleofaccounts
receivableorascheduleof
royalties.Answer(b)isincorrect
becauseanauditormayaudita
scheduleofroyalties.Answer(c)is
incorrectbecauseanauditormay
auditascheduleofaccounts
receivable.Answer(d)isincorrect
becauseanauditormayauditboth
ascheduleofaccountsreceivable
andascheduleofroyalties.
100. (b)Therequirementistoidentifyan
auditorsreportingresponsibility
whenaprintedformprescribesthe
wordingoftheindependent
auditorsreportthatwillaccom
panyit,butthatwordingisnot
acceptabletotheauditor.AU623
suggeststhattheauditorrewordthe
report(orattachaseparatereport)
wheninvolvedwiththistypeof
specialreport.
C.2.b.LettersforUnderwriters
101. (a) The requirement is to
determine a predecessorauditors
responsibility when the financial
statements he or she audited are
being included in an SEC
registration statement filing.
Answer(a)iscorrectbecauseAU
711 requires that the predecessor
(1) read pertinent portions of the
docu
ment,and(2)obtainaletterof
representationfromthesuccessor
auditor.
willbeincludedonthepro
spectivefinancialstatements.
106. (d)Therequirementisto
determinetheappropriate
referencetoan
independentaccountant
inaprospectus(relating
toanSECregistration
statement)thatincludesa
statementabouthis/her
involvementwithan
independentauditreport.
AU711indicatesthatthe
independentaccountant
isanexpertinauditing
andaccounting.
102. (b)Therequirementistoidentify
thestatementthatiscorrect
concerninglettersforunderwriters.
Answer(b)iscorrectbecauseletters
forunderwriterstypicallyprovide
negativeassuranceonunaudited
interimfinancialinformation.
Answer(a)isincorrectbecause
lettersforunderwritersarenot
requiredbytheSecuritiesActof
1933.Answer(c)isincorrect
becauselettersforunderwritersare
notincludedinregistrations
statements.Answer(d)isincorrect 107. (d)Therequirementistoidentify
theinformationincludedinatypical
becauseauditorsopinionsonthe
comfortletter.Answer(d)iscorrect
prioryearsfinancialstatementare
becauseinacomfortletterauditors
notupdated.
provideanopinionastowhether
103. (a)Therequirementisto
theauditedfinancialstatements
determine whoordinarily
complyinformwiththeaccounting
signs a comfort letter.
requirementsoftheSEC.Answer
Answer (a) is correct
(a)isincorrectbecausenegative
because a comfort letter
assuranceconcerningwhetherthe
(alsoknownaslettertoan
entitysinternalcontrolprocedures
underwriter)issentbythe
operatedasdesignedduringthe
independentauditortothe
periodisnotprovided.Answer(b)
underwriter.
isincorrectbecauseacomfortletter
doesnotincludeanopinionon
104. (d)Therequirementisto
whethertheentitycompliedwith
identifytowhomcomfort
GovernmentAuditingStandards
lettersareordinarily
andtheSingleAuditAct.Answer
addressed.Answer(d)is
(c)isincorrectbecausenegative,
correctbecausecomfort
notpositive,assuranceisprovided
letters,alsoreferredtoas
onunauditedcondensedfinancial
lettersforunderwriters,
information.
areordinarilyaddressed
tounderwriters.
108. (a)Therequirementisto
determinethepropertreat
105. (a)Therequirementistodetermine
mentofunaudited
thetypeofopinionorassurance
financialstatements
providedbyanaccountantwhoissues
presentedincomparative
a
formwithaudited
comfortlettercontaining
financialstatementsina
commentsondatathathavenot
documentfiledwiththe
beenaudited.Answer(a)iscorrect
SecuritiesandExchange
becausewhenproceduresshortof
Commission.Answer(a)
anauditareappliedtoinformation
iscorrectbecausethose
suchascapsuleinformation,a
statementsshouldbe
comfortletterwillgenerally
markedunaudited,not
providenegativeassurance.
withhelduntiltheyare
Answer(b)isincorrectbecause
audited,andnotreferred
CPAsdonotprovidepositive
tointheauditorsreport.
assuranceonsupplementary
109. (b)Therequirementisto
disclosures.Answer(c)is
identifytherequirement
incorrectbecausenolimited
relatingtoaCPAsreport
opinionisissuedonproformaor
otherinformation.Answer(d)is
whenreportingonthe
incorrectbecausenodisclaimer
application
194
ofaccountingprinciplestoa
specifictransaction.Answer(b)is
correctbecauseAU625requires
thatthereportincludeastatement
thatresponsibilityfortheproper
accountingtreatmentrestswiththe
preparersofthefinancial
MODULE5REPORTING
action.Answer(b)isincorrect
becausetheengagementsfindings
neednotbereportedtoallofthe
groupslistedtheentitysaudit
committee,thecontinuingCPA,and
management.Answer(c)isincorrect
becausetheaccountantneednot
disclaimanopinion.Answer(d)is
incorrectbecausethereports
distributionneednotberestrictedto
managementandoutsidepartieswho
areawareofallrelevantfacts.
statements.Answer(a)isincorrect
becausethereportstatesthatthe
engagementwasperformedin
accordancewithapplicableAICPA
112. (b)Answer(b)iscorrectbecause
standards,notStatementson
AU625indicatesthatanaccountant
StandardsforAccountingand
shouldnotundertakesuchan
ReviewServices.Answer(c)is
engagementwhenthereportwould
incorrectasnosuchstatementabout
opinionshoppingisincluded.An
bebasedonsuchahypothetical
swer(d)isincorrectbecausethe
transaction.Answers(a),(c),and
informationmaybecommunicated
(d)areallincorrectbecausethey
toapriororcontinuingauditor.
includeinformationincludedinan
accountantsreportonthe
C.2.c. ApplicationofAccounting
applicationofaccountingprinciples.
Principles
C.3.a.AttestationEngagements
110. (a)Therequirementistodetermine
General
anauditorsreportingresponsibility
whenaskedbyaprospectiveclient
113.(c)Therequirementistoselect
torenderanopiniononthe
theservicethatismostlikelytobe
applicationofaccountingprinci
structuredasanattestengagement.
plestoaspecifictransaction.
Answer(c)iscorrectbecause
Answer(a)iscorrectbecauseAU
CPAsmayprovideassuranceasto
625indicatesthatthereportmust
compliancewithrequirementsof
includeastatementthatany
specifiedlawsthroughavarietyof
differenceinthefacts,
services,includingagreedupon
circumstances,orassumptions
proceduresengagementsand
presentedmaychangethereport,as
variouscomplianceaudits.Answers
wellasvariousotherdisclosures.
(a)
Answer(b)isincorrectbecausethe
and(b)areincorrectbecause
reportindicatesthattheengagement
advocatingaclientstaxposition
wasperformedinaccordancewith
andconsultingonanewdatabase
AICPAstandards,notStatements
systemareexamplesof
onStandardsforConsulting
professionalservicesnottypically
Services.Answer(c)isincorrect
structuredasattestservices.
becausethereportneednotindicate
Answer(d)isincorrectbecause
thattheguidanceisformanagement
compilationsarenotaformof
useonlyandmaynotbe
attestengagement.
communicatedtothepriororcon
tinuingauditors.Answer(d)is
incorrectbecausethereportdoes
notincludenegativeassurance
(nothingcametoourattention).
SeeAU625forperformanceand
reportingstandardsrelatingto
reportsontheapplicationof
accountingprinciples.
111. (a)Therequirementistodetermine
anauditorsresponsibilitywhen
askedtorenderanopiniononthe
applicationofaccountingprinciples
toaspecifictransactionbyanentity
thatisauditedbyanotherCPA.
Answer(a)iscorrectbecausethe
accountantmustconsultwiththe
continuingCPAtoattempttoobtain
informationrelevanttothetrans
114. (c)Answer(c)iscorrect
because AT 101
indicatesthat
an
unqualified
may
ordinarily refer to that
assertion or to the
subject matter to which
the assertion relates.
Answer
(a)isincorrectbecauseitsuggests
reportingonlyontheassertion.
Answer(b)isincorrectbecauseit
suggestsreportingonlyonthesubject
matter.Answer(d)isincorrect
becauseitsuggeststhatreportingon
neithertheassertionnorthesubject
matterisappropriate.Note,however,
thatAT
101 alsostatesthatwhena
deviationfromthe
criteriabeingreported
uponexits(e.g.,a
materialweaknessin
internalcontrolthe
CPAshouldreport
directlyuponthesubject
matterandnotuponthe
assertion.
115. (a)Therequirementisto
identifythecorrectstate
ment.Whenastandard
unqualifiedexamination
reportisbeingissued,
thatreportmaybeupon
thesubjectmatterorthe
writtenassertion.
Answers(b),(c),and(d)
areallincorrectbecause
theysuggestthatthe
reportmaynotbeupon
eitherthesubjectmatter,
thewrittenassertion,or
both.
116. (b)Therequirementisto
determinewhethera
CPAsconclusionmaybe
uponthesubjectmatter,
thewrittenassertion,or
bothwhenconditions
existthatresultina
materialdeviationfrom
thecriteriaagainstwhich
thesubjectmatterwas
evaluatedduringan
examination.Answer(b)
iscorrectbecauseinsuch
circumstancesthe
conclusionshouldbe
directlyuponthesubject
matter.Answer(a)is
incorrectbecauseit
suggeststhatthe
conclusionmaybeupon
thewrittenassertion.
Answer(c)isincorrect
becauseitstatesthatthe
conclusionmaynotbe
uponthesubjectmatter
andmaybeuponthe
writtenassertion.Answer
(d)isincorrectbecauseit
statesthattheconclusion
maynotbeuponthe
subjectmatter.
117. (a)Therequirementisto
determinetheelementthat
isleastlikelytobe
presentwhena
practitionerperformsan
attestengagement.
Answer(a)iscorrect
becausewhileanassertion
isgenerallypresent,itis
notordinarilyrequired.
Answers(b),(c),and(d)
areallincorrectbecause
practitioner
independence,subject
matter,andsuitable
criteriaareallrequired.
118. (a)Therequirementistodetermine
whethersuitablecriteriainan
attestationengagementmaybe
availablepublicly,and/orinthe
CPAsreport.Answer(a)iscorrect
becausesuitablecriteriamaybe
availablepubliclyintheCPAs
report,includedwiththesubject
matterorintheassertion,well
understoodbyusers(e.g.,the
distancebetweenAandBistwenty
feet)oravailableonlytospecified
parties.Answers(b),(c),and(d)are
allincorrectbecausetheysuggest
thatsuitablecriteriamaynotbe
availablepublicly,intheCPAs
report,orboth.
119. (d)Therequirementisto
identifythesituationthat
isleastlikelytoresultin
arestricteduseattest
report.Answer(d)is
correctbecausecriteria
developedbyanindustry
associationmayormay
notresultinarestricted
useattestreport.Answers
(a),(b),and(c)always
resultinarestricteduse
report.
120. (c)Therequirementisto
identifytheinformation
thatisleastlikelytobe
includedinanagreed
uponprocedures
attestationreport.
Answer(c)iscorrect
becauseanagreedupon
proceduresreport
providesasummaryof
proceduresperformed
andfindings,notlimited
assurance.Answer(a)is
incorrectbecausethe
specifiedpartydoesnot
takeresponsibilityforthe
sufficiencyof
procedures.An
MODULE5REPORTING
swer(b)isincorrectbecausethe
reportsuseisrestricted.Answer
(d) is incorrect because a
summary of procedures
performedisincluded.
121.(a)Therequirementisto
identifythetypeofreportthatis
mostlikelytoincludeasummary
offindingsratherthanassurance.
Answer(a)iscorrectbecause
agreeduponproceduresreports
includeasummaryoffindings.An
swer(b)isincorrectbecausea
compilationreportdoesnotprovide
asummaryoffindings.Answer(c)
isincorrectbecausean
examinationreportincludes
positiveassuranceandnota
summaryoffindings.Answer(d)is
incorrectbecauseareviewreport
includeslimited(negative)
assurance,notasummaryof
findings.
C.3.b.AgreedUponProcedures
Engagements
122.(c)Therequirementisto
identifythestatementthatisnot
correctconcerningspecified
partiesofanagreedupon
proceduresreportundereitherthe
auditingorattestationstandards.
Answer(c)iscorrectbecausewhile
apractitionershouldestablisha
clearunderstandingregardingthe
termsoftheengagement,preferably
inanengagementletter,nosuch
engagementletterisrequired.
Answers(a)and(b)areincorrect
becausethespecifiedpartiesmust
agreeontheprocedurestobe
performedandtakeresponsibility
fortheiradequacy.Answer(d)is
incorrectbecauseanadditional
partymaybeaddedasaspecified
partyaftercompletionofthe
engagement.
C.3.c. FinancialForecastsand
Projections
123. (a)Therequirementistodetermine
theinformationtobeincludedina
separateparagraphincludedinan
accountantsreportonthe
examinationofprojectedfinancial
statements.Answer(a)iscorrect
becauseAT301requiresthatsucha
reportincludeaseparateparagraph
thatdescribesthelimitationsonthe
usefulnessofthepresentation.See
AT301forinformationthatshould
beincludedinanexamination
reportofprospectivefinancial
195
statements.An
swer(b)isincorrectbecausethe
reportincludesnosuchstatement
attemptingtodistinguishbetween
anexaminationandanaudit.
Answer(c)isincorrectbecausethe
reportincludesnosuchdisclosure
andbecausetheaccountantisnot
responsibleforeventsand
circumstancesuptooneyearafter
thereportsdate.Answer(d)is
incorrectbecausethereport
suggeststhattheassumptionsdo
provideareasonablebasis.
124. (a)Therequirementisto
identifythecircumstancein
whichanaccountantmay
acceptanengagementto
applyagreedupon
procedurestoprospective
financialstatements.
Answer(a)iscorrect
becauseAT301statesthat
anaccountantmayaccept
anengagementtoapply
agreeduponproceduresto
prospectivefinancial
statementsprovidedthat(1)
thespecifiedparties
involvedhaveparticipated
inestablishingthenature
andscopeofthe
engagementandtake
responsibilityforthe
adequacyoftheprocedures
tobeperformed,
(2)useofthereportistobe
restrictedtospecifiedparties
involved,and(3)theprospective
financialstatementsincludea
summaryofsignificant
assumptions.Answer(b)is
incorrectbecausetheprospective
financialstatementsneednotbe
examined.Answer(c)isincorrect
becauseresponsibilityforthe
adequacyoftheproceduresistaken
bythespecifiedparties.Answer(d)
isincorrectbecauseasummaryof
findingsmaybeprovidedbasedon
theagreeduponprocedures.
125. (c)Therequirementisto
identifythestatement
whichshouldbe
includedinan
accountants
compilationreporton
financialforecasts.
Answer(c)iscorrect
becausewhenthe
accountantispreparinga
standardcompilation
reportonprospective
financialstatements,AT
301requiresthatthe
accountantincludea
statementindicatingthat
theprospectiveresults
maynotbeachieved.
126. (c)Therequirementisto
identifytheappropriate
distributionofanentitys
financialprojection.A
financialprojectionis
sometimespreparedto
presentoneormore
hypotheticalcoursesof
actionforevaluationin
responsetoaquestion
suchasWhatwould
happenif...?Itisbased
onaresponsiblepartys
assumptionsreflecting
conditionsitexpects
wouldexistandthe
courseofactionitexpects
wouldbetaken,givenone
ormorehypothetical
assumptions.Projections
arelimitedusefinancial
statementsmeantforthe
responsibleparty
(generallymanagement)
andthirdpartieswith
whomtheresponsible
partyisnegotiating
directly.Answer(c)is
correctbecauseabank
mightbeexpectedto
receivesuchaprojection.
Answers(a),(b),and(d)
areallincorrectbecause
projectionsaremeantfor
limiteduseandnotto
bebroadlydistributedto
groupssuchasallem
ployeesorpotentialor
currentstockholders.AT
301providesoverall
guidanceontheareaof
financialforecastsand
projections.
127. (c)Therequirementisto
determinewhethereither
testifyingasanexpert
witness,compilinga
financialprojection,or
bothareengagements
governedbythe
provisionsofthe
StatementonStandards
forAttestationStatements.
Answer(c)iscorrect
becausetheattestation
standardsexplicitly
excludeexpertwitness
work,butincludethe
compilationofafinancial
projection;notethatin
mostareascompilations
arenotincludedin
attestationstandard
coverage,butinthearea
ofprospectivefinancial
statement(forecastsas
wellasprojections)
coverageisincluded.
Answer(a)isincorrect
becauseitstatesthat
expertwitnessworkisin
cluded.Answer(b)is
incorrectbothbecauseit
statesthatexpertwitness
workisincludedandthat
compilingaprojectionis
notincluded.Answer(d)
isincorrectbecauseit
statesthatcompilationsof
projectionsarenot
included.
128. (a)Therequirementisto
identifythestatementthat
shouldbeincludedina
compilationreportona
financialforecast.
Answer(a)iscorrect
becausethereportshould
statethatthecompilation
doesnotinclude
evaluationofthesupport
oftheassumptions
underlyingtheforecast.
Answer(b)isincorrect
becausenosuch
statementisincludedina
compilationreport,and
becausehypothetical
assumptionspertainto
financialprojections,not
financialforecasts.
Answer(c)isincorrect
becausethereportmakes
nostatementconcerning
therangeofassumptions.
Answer(d)isincorrect
becausethestatementis
notincludedinthereport,
andbecausethe
prospectivestatements
aremanagements,not
theaccountants,
representation.
129. (d)Therequirementistoidentify
thetypeofgeneraluseprospective
financialstatementonwhichthe
accountantmayappropriately
report.Answer(d)iscorrect
becausefinancialforecastsare
consideredprospectivefinancial
statements,andtheyareappropriate
forgeneraluse.Answer(a)is
incorrectbecausefinancial
projectionsareonlyappropriatefor
thepartyresponsibleforpreparing
themorforthirdpartieswithwhom
theresponsiblepartyisnegotiating
directly.Answers(b)and(c)are
incorrectbecause
MODULE5REPORTING
196
partialpresentationsandpro
formafinancialstatementsarenot
consideredprospectivefinancial
statements.
130. (b)Therequirementisto
identifythetypeofpro
spectivefinancial
statementthatincludes
oneormorehypothetical
(whatif?)assumptions.
Answer(b)iscorrect
becausefinancial
projectionsincludeoneor
morehypothetical
assumptions.Answer(a)
isincorrectbecausepro
formafinancial
presentationsaredesigned
todemonstratetheeffect
ofafutureorhypothetical
transactionbyshowing
howitmighthave
affectedthehistorical
financialstatementsifit
hadbeenconsummated
duringtheperiodcovered
bythosestatements.
Answer(c)isincorrect
becausepartialpresen
tationsarepresentations
thatdonotmeetthe
minimumpresentation
guidelinesofAT301.
Answer(d)isincorrect
becausefinancial
forecastspresent,tothe
bestoftheresponsible
partysknowledgeand
belief,anentitys
expectedfinancial
position,resultsof
operations,andchangesin
financialinformation.
131. (d)Therequirementistodetermine
anaccountantsresponsibilitywhen
heorsheacceptsanengagementto
applyagreeduponproceduresto
prospectivefinancialstatements.
Answer(d)iscorrectbecause
distributionofsuchareportistobe
restrictedtothespecifiedparties
involved.AT301alsorequiresthat
thespecifiedpartiesparticipatein
establishingandtaking
responsibilityfortheadequacyof
theprocedures,andthatthe
prospectivefinancialstatements
includeasummaryofsignificant
assumptions.Answer(a)isincorrect
becausetheprospectivefinancial
statementsneednotbeexamined.
Answer(b)isincorrectbecausere
sponsibilityfortheadequacyofthe
proceduresistakenbythespecified
parties,notbytheaccountant.
Answer(c)isincorrectbecause
whentheaccountantreportsonthe
resultsofapplyingagreedupon
proceduresheorsheshouldnot
expressanyformofnegative
assuranceontheprospective
financialstatementstakenasa
whole.
132. (d)Therequirementistodetermine
theappropriatetypeofauditreport
tobeissuedwhenanaccountant
examinesafinancialforecastthat
failstodiscloseseveralsignificant
assumptionsusedtopreparethe
forecast.AT301statesthatan
adverseopinionisappropriatewhen
significantassumptionsarenot
disclosed.
C.3.d.ProFormaFinancial
Information
133.(d)Therequirementisto
determinethestatementthatshould
beincludedinanaccountants
reportonareviewofproforma
financialinformation.Answer(d)is
correctbecausethereportmust
includeareferencetothefinancial
statementsfromwhichthehistorical
financialinformationisderivedand
astatementastowhethersuch
financialstatementswereaudited
orreviewed.
C.3.e. ManagementDiscussion
andAnalysis
134. (b)Therequirementisto
determinethereplythatis
notanobjectiveofa
CPAsexaminationofa
clientsMD&A.Answer
(b)iscorrectbecausean
examinationofaclients
MD&Adoesnotdirectly
addressoverall
conformitywithsuch
rulesandregulations.
Answers(a),(c),and(d)
arethethreeobjectivesof
anMD&Aexamination
agreement.
135. (c)Therequirementisto
identifyanassertionem
bodiedinMD&A.Answer
(c)iscorrectbecausethe
attestationstandardson
MD&Aindicatethat
consistencywith
thefinancialstatementsisan
assertioninaddition,occurrence,
completeness,andpresentationand
disclosureareembodiedassertions.
Answers(a),(b),and(d)areall
incorrectbecausevaluation,
reliability,andrightsandobligations
arenotconsideredtobeassertions
embodiedintheMD&A.
136.(b)Answer(b)iscorrect
becausetheMD&Areviewofan
issuer(public)entityshouldbe
restrictedtotheuseofspecified
parties.Answer(a)isincorrect
becauseareviewconsists
principallyofapplyinganalytical
procedures,ratherthanalso
includingsearchandverification
procedures.Answer(c)isincorrect
becauseaconsiderationofrelevant
portionofinternalcontrolis
necessarytoidentifytypesof
potentialmisstatementsandto
selecttheinquiriesandanalytical
procedures.Answer(d)isincorrect
becauseareviewreportordinarily
providesnegativeassurance,nota
summaryoffindings.
C.3.f. TrustServices
137. (d)Therequirementisto
identifytheproperterm
foranattestengagement
inwhichaCPAassessesa
clientscommercial
Internetsiteforpredefined
criteriasuchasthoseover
onlineprivacy.Answer
(d)iscorrectbecausethe
AICPAsTrustServices
Principlesrelatetothis
area,andWebTrustisthe
mostlikelyproductsee
www.aicpa.org.Answers
(a),(b),and(c)all
representnamesof
productsnotincludedin
theprofessionalstandards.
138. (b)Therequirementisto
identifythestandardsun
derwhichTrustServices
engagementsare
performed.Answer(b)is
correctbecausethe
StatementsonStandards
forAttestation
engagementsaddresssuch
engagements.More
informationonTrust
Servicesengagements
(WebTrustandSysTrust)
isavailableonthe
AICPAsWebsite
www.aicpa.org.Answers
(a)and(c)areincorrect
becausesuchstandardsdo
notexist.Answer(d)is
incorrectbecause
StatementsonAuditing
Standardsdonotaddress
TrustServices
engagements.
139. (d)Therequirementistoidentify
whattheWebTrustsealof
assurancerelatesmostdirectlyto.
Answer(d)iscorrectbecausethe
WebTrustsealisdesignedto
provideassuranceonWebsite
security,availability,processingin
tegrity,onlineprivacyand
confidentiality.Answers(a),(b),
and(c)areallincorrectsince
WebTrustisntspeciallyaimedat
financialstatements,healthcare
facilities,orriskassurance
procedures.
140. (b)Therequirementisto
determinethetypeof
opinionorassurancemost
likelytobeincludedina
CPAsreportrelatingto
WebTrustengagements.
Answer(b)iscorrect
becausetheWebTrust
examinationreport
providesanopinionon
whetherthesitemeetsthe
TrustServicescriteria
foroneormoreofthe
TrustServicesPrinciples.
Answer(a)isincorrect
becausenoopinionon
beinghackproofis
issued.Answer(c)is
incorrectbecause
negativeassuranceisnot
provided.Answer(d)is
incorrectbecausean
agreeduponprocedures
engagement,notan
examinationengagement
resultsinasummaryof
findings.
141. (b)Therequirementisto
identifythetypeofen
gagementthatconsiders
security,availability,
processingintegrity,
onlineprivacyand/or
confidentialityoverany
typeofdefinedelectronic
system.Answer(b)is
correctbecauseSysTrust
engagementsconsiderany
typeofdefinedelectronic
system.Answer(a)is
incorrectbecauseanen
MODULE5REPORTING
gagement to consider internal
control over financial reporting
does not directly address these
attributes. Answer (c) is incorrect
because there is no such
engagement as a Web site
Associate.Answer(d)isincorrect
because WebTrust deals more
directlywithcompanyWebsites.
142.(b)Therequirementisto
identifythemostlikelyreportwhen
aclientrefusestoprovideawritten
assertioninaTrustServices
engagement.Answer(b)iscorrect
becausethisrepresentsascope
limitation,andclientimposedscope
limitationsaremostlikelytoresult
inadisclaimerofopinion.Answer
(a)isincorrectbecauseanadverse
opinionisappropriatewhenaCPA
believesthattheinformationisso
misstatedastobemisleading.
Answer(c)isincorrectbecause
clientimposedscopelimitations
generallyresultindisclaimers,not
qualifiedopinions.Answer(d)is
incorrectbecauseanunqualified
opinionismostlikelynot
appropriateinsuchacircumstance.
D.1.a.ComplianceAttestation
EngagementsAgreed
UponProcedures
Engagements
143. (c)Therequirementisto
identifythetypeofasso
ciation not permitted
under the compliance
attestationstandards.AT
601 does not allow the
CPAtoperformareview
overcompliance.
144. (b)Therequirementistoidentify
theinformationprovidedinan
agreeduponproceduresreporton
compliancewithcontractual
requirementstopayroyalties.
Answer(b)iscorrectbecause
agreeduponproceduresreports
includealistoftheprocedures
performed(orreferencethereto)and
findings.Answer(a)isincorrect
becausenosuchdisclaimerof
opinionisprovidedinanagreed
uponproceduresreport.Answer(c)
isincorrectbecausenoopinionis
includedinanagreedupon
proceduresreport.Answer(d)is
incorrectbecauseanagreedupon
proceduresreportincludesa
statementdisclaiminganopinionon
thesufficiencyofprocedures,notan
acknowledgementofthesufficiency
197
oftheprocedures.SeeAT201for
guidanceonagreedupon
proceduresengagements.
145. (a)Therequirementisto
identifythestatementthat
isincludedinaCPAs
reportonagreedupon
procedureson
managementsassertion
aboutanentitys
compliancewith
specifiedrequirements.
Answer(a)iscorrect
becausesuchanagreed
uponproceduresreport
includesastatementof
limitationsontheuseof
thereportbecauseitis
intendedsolelyforthe
useofspecifiedparties.
SeeAT601forin
formationthatshouldbe
includedinsuchan
agreeduponprocedures
report.Answer(b)is
incorrectbecauseno
opinionisincluded.
Answer(c)isincorrect
becauseasummaryof
findings,notnegative
assuranceisprovided.
Answer(d)isincorrect
becausetheCPAmakes
norepresentation
regardingthesufficiency
ofprocedures.
D.1.b.ComplianceAttestation
Engagements
Examination
Engagements
146.(c)Therequirementisto
identifythecorrectstatement
concerninganexaminationreport
whenmanagementhasproperly
disclosedaninstanceofmaterial
noncompliance.AT601states
thattheopinionshouldbe
qualifiedoradverse.NotethatAT
601requirestheCPAsreportto
relatedirectlytothesubject
matterwhentheopinionis
modified.
D.2.a.ComplianceAuditingof
FederalFinancialAssis
tancePrograms
GAASAudits
147. (b)Therequirementistodetermine
anauditorsresponsibilitywhen
auditinganotforprofitentitythatre
ceivesgovernmentalfinancial
assistance.Answer(b)iscorrect
becauseAU801requiresthatthe
auditorassesswhethermanagement
hasidentifiedlawsandregulations
thathaveadirectandmaterialeffect
ontheentitysfinancialstatements;
AU801alsopresentsproceduresto
befollowedinassessingsuchlaws
andregulations.Answer(a)isincor
rectbecausesuchaseparatereport
describingexpectedbenefitsandcosts
doesnotneedtobeissued.Answer
(c)isincorrectbecausetheCPAwill
notnotifythegovernmentalagency
thattheauditisnotdesignedto
provideassurance.Answer(d)is
incorrectbecausetheCPAdoesnot
expressanopinionontheentitys
continuedeligibilityforgovernmen
talfinancialassistance.AU801
presentsrequirementsrelatingto
complianceauditingforgovernmental
entitiesandrecipientsof
governmentalfinancialassistance.
148. (c)Therequirementisto
determinethefocusofan
auditorsattentionin
detectingmisstatements
resultingfromviolationsof
lawsandregulationswhen
auditinganotforprofit
organizationthatreceives
financialassistancefrom
governmentalagencies.
Answer(c)iscorrect
becausethefocusofsuch
proceduresshouldbeon
violationsthathaveadirect
andmaterialeffectonthe
amountsintheorganiza
tionsfinancialstatements
(AU801).Answers(a),(b),
and(d)allrepresentafocusthat
is not as accurate as that
providedinanswer(c).
149. (b)Therequirementisto
determinetheproper
scopeofagovernmental
audit.TheGeneral
AccountingOffices
YellowBooksuggests
thatinadditionto
financialstatements,such
anauditmayinclude
considerationof
(1) program results, (2)
compliance with laws and
regulations, and (3) economy
andefficiency.
150. (b)Therequirementistoidentify
whetheranauditorperformingan
auditinaccordancewith
GovernmentAuditingStandards
(theYellowBook)isrequiredto
reportonnoteworthy
accomplishmentsoftheprogram,
thescopeoftheauditorstestingof
internalcontrols,orboth.Answer
(b)iscorrectbecausetheyellow
bookrequiresreportingonlyupon
thescopeoftheauditorstestingof
internalcontrols.Answers(a),(c),
and(d)allincludeanincorrect
combinationofreportingreplies.
151. (b)Therequirementisto
identifywhetheranauditor
performinganauditin
accordancewith
GovernmentAuditing
Standards(theYellow
Book)isrequiredtoreport
onrecommendationsfor
actionstoimprove
operations,thescopeof
testsofcompliancewith
lawsandregulations,or
both.Answer(b)iscorrect
becausetheyellowbook
requiresreportinguponthe
scopeoftheauditorstests
ofcompliancewithlaws
andregulations.Answers
(a),(c),and
MODULE5REPORTING
198
becauseafinancialstatementaudit
doesnotaddresseconomyand
efficiencyinthemannersuggested.
Answer(c)isincorrectbecause
recommendationsforactionsto
correctproblemsandimprove
operationsarenotordinarilyin
cluded.Answer(d)isincorrect
becauseafinancialstatementaudit
doesnotaddresswhetherprograms
areachievingthedesiredresults.
153. (a)Therequirementistoidentify
thecorrectstatementwithrespect
toafinancialstatementaudit
conductedinaccordancewith
GovernmentAuditingStandards
(theYellowBook).Answer(a)is
correctbecausetheauditorissuesa
reportoncompliancewithlawsand
internalcontrol,andareportonthe
financialinformation.Answer(b)is
incorrectbecausenotallinstances
ofabuse,wasteandmismanage
mentaresoreported.Answer(c)is
incorrectbecausetheviewsof
officialsarenotreported.Answer
(d)isincorrectbecauseinternal
controlactivitiesdesignedtodetect
orpreventfraudarenotreportedto
theinspectorgeneral.
154. (d)The
requirementis
toidentifythe
circumstancein
whichan
auditoris
requiredto
reporta
falsificationof
accounting
recordsdirectly
toafederal
inspector
general.Answer
(d)iscorrect
becauseunder
Government
Auditing
Standardsa
falsificationof
accounting
recordsmust
ordinarilybe
communicated
bytheauditor
totheauditee
and,ifthe
auditeefailsto
make
appropriate
disclosure,by
theauditortoa
federal
inspector
general.
Answers(a),
(b),and
(c) allprovideinaccurate
descriptionsofauditor
reportingresponsibility.
SeeGovernment
AuditingStandards(the
YellowBook)for
informationonreporting
underGovernment
AuditingStandards.
155. (a)Therequirementistoidentifya
commonaspectofvarioustypesof
auditsofrecipientsoffederal
financialassistanceinaccordance
withfederalauditregulations.An
swer(a)iscorrectbecauseauditsof
recipientsoffederalfinancial
assistanceincludereportson(1)the
financialstatements,and(2)a
separateorcombinedreporton
internalcontrolandoncompliance
withlawsandregulations.Answer
(b)isincorrectbecausemateriality
levelsarenotordinarilyloweror
alwaysdeterminedbythe
governmentalentity.Answer(c)is
incorrectbecausetheauditorneed
notobtainsuchwrittenmanagement
representations.An
swer(d)isincorrectbecause
requirementsforreportingillegal
actsmayvarydependinguponthe
typeofauditbeingperformed.AU
801providesrequirementsrelated
toauditingentitiesthathave
receivedgovernmentalfinancial
assistance.Inaddition,guidanceis
providedbyGovernmentAuditing
Standards(GAS),alsoreferredto
astheYellowBook,publishedby
theComptrollerGeneralofthe
UnitedStates.
156. (b)Therequirementistoidentifyto
whomanauditormostlikelywould
beresponsibleforcommunicating
significantdeficienciesinthedesign
ofinternalcontrol.Answer(b)is
correctbecauseinauditsunder
GovernmentAuditingStandards,
significantdeficienciesinthedesign
ofinternalcontrolare
communicatedtolegislativeand
regulatorybodies(AU801).
Answer(a)isincorrectbecausethe
SecuritiesandExchange
Commissiondoesnotordinarily
receiveinformationonsuch
deficiencies.Answer(c)isincorrect
becausewhileacourtappointed
creditorscommitteemightinsome
circumstancesreceiveinformation
onsuchdeficiencies,thispracticeis
notasfrequentasisdoneunder
GovernmentAuditingStandards.
Answer(d)isincor
rectbecauseshareholdersdonot
normallyreceivereportson
significantdeficienciesormaterial
weaknesses(seeAU325).
157. (c)Therequirementistodetermine
theopinionwhichanauditorshould
expressinareportoncompliance
whens/hehasdetectedmaterial
instancesofnoncompliancewithin
theprogram.AU801definesthese
instancesofmaterial
noncomplianceasfailurestofollow
requirements,orviolationsof
regulationsorgrantswhichcause
theauditortoconcludethatthetotal
ofthemisstatementsresultingfrom
thesefailuresorviolationsis
materialtothefinancialstatements.
Therefore,answer(c)iscorrect
becausetheauditorshouldissuea
qualifiedoranadverseopinion.
Answer(a)isincorrectbecausethe
auditorisrequiredunder
GovernmentalAuditingStandards
toprovidereasonableassuranceon
theentityscompliancewiththe
applicablelawsandregulations.
Answer(b)isincorrectbecausethe
auditormustdisclosetheinstances
ofnoncompliance.Answer(d)is
incorrectbecausetheauditor
shouldnotdisclaimanopinionasa
resultofnoncompliance.
158. (b)Therequirementisto
determineadocumenta
tionrequirementthatan
auditorshouldfollow
whenauditingin
accordancewith(also
referredtoasthe
YellowBook).Answer
(b)iscorrectbecause
GovernmentAuditing
Standardsrequire
documentationof
supervisoryreview
beforethereportis
issued.
159. (a)Therequirementisto
identifythestatementthat
shouldbeincludedinan
auditorsreportonan
entityscompliancewith
lawsandregulations
whenperforminganaudit
inaccordancewith
GovernmentAuditing
Standards.Answer(a)is
correctbecausesuch
compliancereportsre
quireastatementthat
managementis
responsibleforcom
pliancewithlaws,
regulations,contracts,
andgrants.SeeAU801
forthisrequirementand
others.
160. (b)Therequirementisto
determinewhenan
auditorreportingunder
wouldmostlikelybe
requiredtocommunicate
managements
misappropriationofassets
directlytoafederal
inspectorgeneral.Answer
(b)iscorrectbecause
GovernmentAuditing
Standardsrequiresthat
whenagoverningbody
failstomakearequired
reportonsuchactsthe
auditorsshould
communicatethematter
totheexternalbody
specifiedinthelawor
regulation.Answer(a)is
incorrectbecausesuch
concealmentwillnot
necessarilyleadtocom
municationtoafederal
inspectorgeneral.Answer
(c)isincorrectbecause
materialmisstatement
doesnotnecessarilylead
tosuchcommunication.
Answer(d)isincorrect
becausetheexpected
durationoftheschemeis
notwhatleadstoreporting
toafederalinspector
general.
D.2.c.ComplianceAuditingof
FederalFinancialAssis
tanceProgramsSingle
AuditAct
161. (b)Therequirementisto
identifytheauditors
propermeasureof
materialityformajor
federalfinancial
assistanceprograms
undertheSingleAudit
Act.AU801requires
thatitbedetermined
separatelyforeachmajor
program.
162. (b)Therequirementisto
identifytheappropriate
compliancereportunder
theSingleAuditAct
whenaCPAhasdetected
noncompliancewith
requirementsthathavea
materialeffectonthat
program.AU801states
thatunder
MODULE5REPORTING
such
circumstan
cesthe
auditor
should
expressa
qualified
oradverse
opinion.
163. (c
)
T
he
re
q
ui
re
m
en
t
is
to
id
en
tif
y
th
e
so
ur
ce
of
au
th
or
it
at
iv
e
g
ui
da
nc
e
fo
r
pe
rf
or
m
in
g
au
di
ts
of
a
ci
ty
th
at
is
199
su
bj
ec
t
to
th
e
re
q
ui
re
m
en
ts
of
th
e
U
ni
fo
r
m
Si
n
gl
e
A
u
di
t
A
ct
of
1
9
8
4.
A
ns
w
er
(c
)
is
co
rr
ec
t
be
ca
us
e
w
hi
le
th
e
A
I
C
P
A
s
ge
ne
ra
ll
y
ac
ce
pt
ed
au
di
ti
n
g
st
an
da
rd
s
m
us
t
be
fo
ll
o
w
ed
to
th
e
ex
te
nt
th
ey
ar
e
pe
rti
ne
nt
,
th
e
G
en
er
al
A
cc
o
u
nt
in
g
O
ffi
ce
G
o
ve
rn
m
en
t
A
u
di
ti
n
g
St
an
da
rd
s
m
us
t
al
so
be
ad
he
re
d
to
.
T
he
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he
r
re
pl
ie
s
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l
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la
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rd
s
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U
ni
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m
Si
n
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e
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u
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t
A
ct
.
164. (c
)
T
h
e
re
q
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re
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e
nt
is
to
id
e
nt
if
y
th
e
c
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ct
st
at
e
m
e
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w
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c
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c
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m
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k
n
es
se
s
in
in
te
rn
al
c
o
nt
ro
l
u
se
d
in
a
d
m
in
is
te
ri
n
g
a
fe
d
er
al
fi
n
a
n
ci
al
as
si
st
a
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e
pr
o
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w
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h
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e
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n
er
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p
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fi
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a
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al
st
at
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m
e
nt
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of
a
m
u
ni
ci
p
al
it
y.
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h
e
A
I
C
P
A
A
c
c
o
u
nt
in
g
a
n
d
A
u
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d
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it
s,
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o
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n
of
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in
re
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to
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fi
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a
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as
si
st
a
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e
pr
o
gr
a
m
.
MODULE5REPORTING
200
SOLUTIONSTOSIMULATIONS
TaskBasedSimulation1
Accounting
Changes
1.
2.
3.
Authoritative
Literature
Help
Theappropriateguidanceregardingreportingonconsistencyisfoundin
AU508.16.18
TheappropriateguidanceregardingemphasisofamatterisfoundinAU
508.19
The appropriate guidance regarding reporting on comparative financial
statementsisfoundinAU508.65.66
TaskBasedSimulation2
Report
Modifications
Authoritative
Literature
Help
1.
(E,P)Whenanauditorhiresaspecialisttoassistincorroboratinga
client estimate (here complex pension calculations), and that
specialistsfindingsarereasonablyclosetothoseoftheclient,no
reportmodificationisrequiredorpermitted.Sincethespecialists
findingssupportthefinancialstatementsinthissituation,astandard
unqualifiedauditreportisappropriate.
When major unresolved differences between the findings of
management and the specialist exist, report modification is
appropriate.
2.
(A,I)Whentheclientsfinancialstatementsmateriallydepartfromgenerally
acceptedaccountingprinciples,eitheraqualifiedopinionoranadverseopinion
isappropriate,dependingonthemagnitudeofthemisstatement.Thevalueof
theclientsnotereceivablehasbeenimpairedandthereforetheclientshould
writethenotereceivabledowntoitsnetrealizablevalue.Theauditorwillhave
todeterminewhethertoissueaqualifiedopinionoranadverseopiniononthe
basisofthematerialityofthemisstatement.Factorstheauditorwillconsider
includethesignificanceoftheaccount,thepervasivenessofthemisstatement
andthemisstatementseffectonthefinancialstatementtakenaswhole.The
auditreport,foreitheropinion,willincludeanexplanatoryparagraphto
describethesubstantivereasonsforthemodification,andtheopinion
paragraphwillbemodified.
3.
4.
(B,J)Asituationwheretheauditorisunabletoobtainsufficient
competentevidentialmatterisreferredtoasascopelimitation.A
scopelimitationmayrequiretheauditortoeitherqualifyhisorher
opinionortodisclaimanopinionaltogether.Sincetheauditorwas
unabletoobservetheinventorycountortoobtainevidencethrough
alternativeprocedures,theauditorwillhavetodecidewhetherto
issueaqualifiedopinionoradisclaimerofopinion.Thedecisionwill
bebasedontheauditorsjudgmentastothenatureandmagnitudeof
thepotentialeffectsofthemattersinquestionandbytheir
significancetothefinancialstatements.Aqualifiedopinionwill
describethecircumstancesinanexplanatoryparagraphandwill
modifythescopeandopinionparagraphs.Adisclaimerofopinion
willomitthescopeparagraphandwillincludemodificationofthe
opinionparagraph.
(E,P)Anauditorneednotmodifyareportforanimmaterialitemthat
theclientdeclinestoreflect.
5.
(A,I)Sincetheclientsfinancialstatementsomittedrequired
disclosuresoncertainlongtermleaseobligations,theyarenot
preparedinaccordancewithgenerallyacceptedaccounting
principles.Asaresult,theauditorshouldexpresseitheraqualified
opinionoranadverseopinion.Thedecisiontoexpresseithera
qualifiedoradverseopinionisbasedonthesignificanceofthelack
ofdisclosure,thepervasivenessofthemisstatement,andtheoverall
effectthelackofdisclosurehasonthefinancialstatements.Theaudit
report,foreitheropinion,willincludeanexplanatoryparagraphto
describethesubstantivereasonsforthemodification,andtheopinion
paragraphwillbemodified.
6.
(E,O)Whenaprincipalauditordecidesnottotakeresponsibilityfor
theworkofanotherauditor,theprincipalauditorshouldmake
referencetotheworkoftheotherauditorintheauditreport.The
auditreportshouldclearlyindicatethedivisionofresponsibility
betweenthetwoauditorsintheintroductory,scope,andopinion
paragraphs.Referencetotheotherauditorintheauditreportdoes
notpreventtheprincipalauditorfromissuinganunqualifiedopinion.
Thereferencetotheotherauditorisdesignedtoemphasizethe
dividedresponsibilitiesbetweenthetwoauditors.
7.
(E,H)Whenanauditoragreeswithachangeinaccounting
principles,alackofconsistencyresultsinanunqualifiedopinion
withanexplanatoryparagraphfollowingtheopinionparagraph.
Thereisnomodificationofthethreestandardparagraphs.
8.
(E,H)Theauditorhassubstantialdoubtabouttheclientsabilityto
remainagoingconcernforareasonableperiodoftime.Theaudit
reportshouldemphasizethisconcerntothefinancialstatement
users.Asaresult,theauditorsreportwillincludeanunqualified
opinionwithanexplanatoryparagraphfollowingtheopinion
paragraph.
MODULE5REPORTING
201
TaskBasedSimulation3
Research
Authoritative
Literature
Help
315
TaskBasedSimulation4
Research
Authoritative
Literature
1.
2.
AU
508
Help
08
TaskBasedSimulation5
AuditReport
Details
Authoritative
Li
te
ra
09
ture
Help
(A)(B)(C)(D)(E)(F)(G)
(I)(J)(K)(L)
1.
2.
RapidPartsCompany,aconsolidatedsubsidiaryofNational,wasaudited
fortheyearendedDecember31,20X2,byGreen&Co.CPAs.
3.
WhitehascompleteditsauditproceduresonMarch28,20X3,and
plannedtosubmititsauditorsreporttoNationalonApril4,20X3.
4.
Themostappropriateaddresseeoftheauditreport.
5.
Nationalsauditreportshouldbesignedby
Explanationofsolutions
1.
2.
3.
5.
(B) Thelackofevidenceaboutthebeginninginventoryaffectsonlythe
resultsofoperations(theincomestatement).
(D) The involvement of the other audit firm results in a division of
responsibilitybecauseWhitedoesnotwanttotakeresponsibilityforthe
otherauditorswork.
(F) Thereportshouldbedatedasofthedatethatallsubstantiveaudit
evidencehasbeenobtained.
4. (I) Ordinarily the report should be addressed to the board of
directors, audit committee, or the company itself, not
management.
(K)OnlyWhite&Co.willsigntheauditreport.
MODULE6ACCOUNTINGANDREVIEWSERVICES
202
ACCOUNTINGANDREVIEWSERVICES
reviewingthefinancial
statements?
MULTIPLECHOICEQUESTIONS(149)
1.
StatementsonStandardsfor
AccountingandReviewServices
establishstandardsandprocedures
forwhichofthefollowing
engagements?
a. Assisting in adjusting
the books of account
forapartnership.
b. Reviewing interim
financial
data
required to be filed
withtheSEC.
c. Processing financial
data for clients of
other accounting
firms.
d. Compiling
an
individuals personal
financial statement to
be used to obtain a
mortgage.
5.
2.
Theauthoritativebodydesignated
topromulgatestandards
concerninganaccountants
associationwithunaudited
financialstatementsofanentitythatisnot
requiredtofilefinancialstatementswith
anagencyregulatingtheissuanceofthe
entityssecuritiesisthe
a. Financial Accounting Standards
Board.
b. GeneralAccountingOffice.
c. Accounting and Review Services
Committee.
d. AuditingStandardsBoard.
3.
Whichofthefollowing
accountingservicesmayan
accountantperformwithout
beingrequiredtoissueacom
pilationorreviewreportunder
theStatementsonStandardsfor
AccountingandReview
Services?
I.Preparingaworkingtrialbalance.
AI. Preparing standard monthly journal
entries.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
NeitherInorII.
4.
Mayanaccountantacceptan
engagementtocompileorreview
thefinancialstatementsofanot
forprofitentityiftheaccountant
isunfamiliarwiththespecialized
industryaccountingprinciples,but
planstoobtaintherequiredlevel
ofknowledgebeforecompilingor
Compilation
No
Yes
No
Yes
a.
b.
c.
d.
6.
Review
No
No
Yes
Yes
Whichofthefollowingstatements
iscorrectconcerningbothan
engagementtocompileandan
engagementtoreviewa
nonissuersfinancialstatements?
a. The accountant
does
not
contemplate
obtaining an
understanding
of internal
control.
b. The
accountant
must be
independent
in fact and
appearance.
c. The
accountant
expresses no
assurance on
the financial
statements.
d. The
accountant
should obtain
a written
management
representation
letter.
Anaccountantisrequiredtocomplywith
theprovisionsofStatementsonStandards
forAccountingandReviewServiceswhen
I.
Reproducing client
prepared
financial
statements, without
modification, as an
accommodation to a
client.
a.
b.
c.
d.
7.
Ionly.
IIonly.
BothIandII.
NeitherInorII.
KellengagedMarch,CPA,tosubmittoKell
awrittenpersonalfinancialplancontaining
unauditedpersonalfinancialstatements.
Marchanticipatesomittingcertaindisclo
suresrequiredbyGAAPbecausethe
engagementssolepurposeistoassistKell
indevelopingapersonalfinancialplan.For
Marchtobeexemptfromcomplyingwith
therequirementsofStatementsonStandards
forAccountingandReviewServices.Kellis
requiredtoagreethatthe
a. Financial
statements will
not
be
presented in
comparative
form with
those of the
priorperiod.
b. Omitted
disclosures
required by
GAAP are
not
material.
c. Financial statements will not be
disclosed to a nonCPA financial
planner.
d. Financial
statements
will not be
used to
obtain
credit.
8.
a.
in
preparing
financial
statements.
c. Proposed
correcting
journal entries
toberecorded
d.
9.
by the client
that change
client
prepared
financial
statements.
Generated,
throughtheuse
ofcomputer
software,
financial
statements
preparedin
accordance
witha
comprehensive
basisof
accounting
otherthan
GAAP.
Davis,CPA,acceptedan
engagementtoauditthefinancial
statementsofTechResources,a
nonissuer.Beforethecompletion
oftheaudit,TechrequestedDavis
tochangetheengagementtoa
compilationoffinancial
statements.BeforeDavisagreesto
changetheengagement,Davisis
requiredtoconsiderthe
a.
b.
c.
d.
Additionalaudit
effortnecessaryto
completetheaudit
No
Yes
Yes
No
Reasongiven
for
Techsrequest
No
Yes
No
Yes
10.Anaccountantmaycompilea
nonissuersfinancialstatementsthatomitall
ofthedisclosuresrequiredbyGAAPonlyif
theomissionis
I.Clearlyindicatedintheaccountants
report.
AI. Not undertaken with the
intention of misleading the
financialstatementusers.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
EitherIorII.
MODULE6ACCOUNTINGANDREVIEWSERVICES
11. Whenengagedtocompilethe
financialstatementsofa
nonissuer(nonpublic)entity,an
accountantisrequiredtopossess
alevelofknowledgeofthe
entitysaccountingprinciplesand
practices.Thisrequirementmost
likelywillincludeobtaininga
generalunderstandingofthe
a. Statedqualificationsoftheentitys
accountingpersonnel.
b. Designoftheentitys
internal controls
placedinoperation.
c. Risk factors relating to
misstatements arising
fromillegalacts.
d. Internal control
awareness of the
entitys
senior
management.
12. Whichofthefollowing
proceduresisordinarilyper
formedbyanaccountantina
compilationengagementofa
nonissuer(nonpublic)entity?
a. Readingthe
financial
statementsto
consider
whetherthey
arefreeof
obvious
mistakesin
the
applicationof
accounting
principles.
b. Obtaining
written
representations
from manage
ment
indicating that
the compiled
financialstate
mentswill not
be used to
obtaincredit.
c. Making
inquiriesof
management
concerning
actionstaken
atmeetingsof
the
stockholders
andtheboard
ofdirectors.
d.
Applying
analytical
procedures
designedto
203
corroborate
managements
assertionsthat
areembodied
inthefinancial
statement
components.
13. Oneoftheconditionsrequiredfor
anaccountanttosubmitawritten
personalfinancialplancontaining
unauditedfinancialstatementstoa
clientwithoutcomplyingwiththe
requirementsofStatementson
StandardsofAccountingand
ReviewServices,isthatthe
a. Client agrees that the
financialstatementswill
not be used to obtain
credit.
b. Accountantcompiled
orreviewedtheclients
financialstatementsfor
theimmediateprior
year.
c. Engagement letter
acknowledges that the
financialstatementswill
contain departures from
generally accepted
accountingprinciples.
d. Accountantexpresses
limitedassurancethat
thefinancial
statementsarefreeof
anymaterial
misstatements.
14. Whileperformingacompilationoffinancial
statements,informationindicatingthatthe
entitywhoseinformationisbeingcompiled
maylacktheabilitytocontinueasagoing
concernhascometotheaccountants
attention.Theclientagreesthatsucha
situationdoesexist,butrefusestoadd
disclosuresrelatingtoit.Whateffectisthis
mostlikelytohaveontheaccountants
reviewreport?
a. No effect, a
standard
unqualified
report
is
appropriate.
b. Thereportshould
indicateadeparturefrom
generallyaccepted
accountingprinciples,
withmodificationofthe
reportsthirdparagraph
andadditionofan
explanatoryparagraph.
c. Anadverseopinion
shouldbeissued,with
modificationofthe
opinionparagraphand
additionofan
explanatoryparagraph.
d.
Aqualifiedopinion
shouldbeissued,with
modificationofthe
opinionparagraphand
additionofan
explanatoryparagraph.
a.
b.
c.
d.
compilation
includes assessing the
accounting principles
used and significant
management esti
mates, as well as
evaluating the overall
financial statement
presentation.
Theaccountant
compiledthefinancial
statementsin
accordancewith
Statementson
Standardsfor
Accountingand
ReviewServices.
Acompilationis
substantiallylessin
scopethananauditin
accordancewithGAAS,
theobjectiveofwhichis
theexpressionofan
opinion.
Theaccountantisnot
awareofanymaterial
modificationsthat
shouldbemadetothe
financialstatementsto
conformwithGAAP.
16. Miller,CPA,isengagedto
compilethefinancialstatements
ofWebCo.,anonissuer
(nonpublic)entity,inconformity
withtheincometaxbasisof
accounting.IfWebsfinancial
statementsdonotdisclosethe
basisofaccountingused,Miller
should
a. Disclose the basis of
accounting in the
accountants
compilationreport.
b. Clearlylabeleachpage
Distribution Restricted
Material
Modifications
Required.
c. Issue a special report
describing the effect
of the incomplete
presentation.
d. Withdraw from the
engagement and
provide no further
servicestoWeb.
17. Whenanaccountantisengaged
tocompileanonissuers
financialstatementsthatomit
substantiallyalldisclosures
requiredbyGAAP,the
b.
accountantshouldindicatein
thecompilationreportthatthe
financialstatementsare
a. Not designed for those
who are uninformed
about the omitted
disclosures.
Prepared in conformity with a
comprehensivebasisofaccounting
otherthanGAAP.
c.
d.
Not compiled in
accordance with
Statements
on
Standards
for
Accounting
and
ReviewServices.
Specialpurpose
financial statements
that are
not
comparabletothoseof
priorperiods.
18. Whenunauditedfinancial
statementsofanonissuerare
presentedincomparativeform
withauditedfinancialstatements
inthesubsequentyear,the
unauditedfinancialstatements
shouldbeclearlymarkedto
indicatetheirstatusand
I.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
EitherIorII.
19.Clark,CPA,compiledandproperly
reportedonthefinancialstatementsof
GreenCo.,anonissuer,fortheyearended
March31,2008.Thesefinancial
statementsomittedsubstantiallyall
disclosuresrequiredbygenerallyaccepted
accountingprinciples(GAAP).Green
askedClarktocompilethestatementsfor
theyearendedMarch31,2009,
MODULE6ACCOUNTINGANDREVIEWSERVICES
204
andtoincludeallGAAPdisclosuresforthe
2009statementsonly,butotherwisepresent
bothyearsfinancialstatementsin
comparativeform.WhatisClarks
responsibilityconcerningtheproposed
engagement?
a. Clarkmaynotreporton
thecomparative
financialstatements
becausethe2008
statementsarenot
comparabletothe2009
statementsthatinclude
theGAAPdisclosures.
b. Clarkmayreporton
thecomparative
financialstatements
providedthe2009
statementsdonot
containanyobvious
material
misstatements.
c. Clarkmayreportonthe
comparativefinancial
statementsprovidedan
explanatoryparagraph
isaddedtoClarks
reportonthe
comparativefinancial
statements.
d. Clarkmayreportonthe
comparativefinancial
statementsprovided
Clarkupdatesthereport
onthe2008statements
thatdonotincludethe
GAAPdisclosures.
20. Whichofthefollowing
statementsshouldnotbein
cludedinanaccountants
standardreportbasedonthecom
pilationofanentitysfinancial
statements?
a. Astatementthatthe
compilationwas
performedinaccordance
withstandards
establishedbythe
AmericanInstituteof
CPAs.
b. A statement that the
accountant has not
auditedorreviewedthe
financialstatements.
c. Astatementthatthe
accountantdoesnot
expressanopinionbut
expressesonlylimited
assuranceonthe
financialstatements.
d.
Astatementthata
compilationislimitedto
presenting,intheform
offinancialstatements,
informationthatisthe
representationof
management.
21. Howdoesanaccountantmakethefollowing
representations when issuing the standard
reportforthecompilationofanonissuers
financialstatements?
a.
b.
c.
d.
Thefinancial
statementshave
notbeenaudited
Implicitly
Explicitly
Implicitly
Explicitly
Theaccountant
hascompiledthe
financialstatements
Implicitly
Explicitly
Explicitly
Implicitly
report.
d.
23. Anaccountanthascompiledthe
financialstatementsofa
nonissuerinaccordancewith
StatementsonStandardsfor
AccountingandReviewServices
(SSARS).DoesSSARSrequire
thatthecompilationreportbe
printedontheaccountants
letterheadandthatthereportbe
manuallysignedbythe
accountant?
a.
b.
c.
d.
Printedonthe
accountantsletterhead
Yes
Yes
No
No
Manuallysigned
bytheaccountant
Yes
No
Yes
No
c.
Notindependentand,therefore,may
trade
association.
25. Whichcommunicationoption(s)
b. Scopeoftheinquiryand
maybeusedwhenanaccountant
analytical procedures
submitscompiledfinancial
hasnotbeenrestricted.
statementstobeusedonlyby
c. Balancesheetisnotto
management?
beusedtoobtaincredit
Compilationreport
Writtenengagementletter
or distributed to
a.
Yes
Yes
creditors.
b.
Yes
No
d.
Specialized accounting
c.
No
Yes
principles and practices
d.
No
No
ofDoversindustryare
26. A compilation report is not
disclosed.
required when compiled
financialstatementsareexpected
tobeusedby
a.
b.
c.
Managementonly.
Managementandthirdparties.
Thirdpartiesonly.
d. Acompilationreportis
required whenever
financial statements
arecompiled.
27. Ifrequestedtoperformareview
engagementforanonissuerin
whichanaccountanthasan
immaterialdirectfinancial
interest,theaccountantis
a. Not independent and, therefore,
may not be associated with the
financialstatements.
b. Not independent and, therefore,
maynotissueareviewreport.
29. Baker,CPA,wasengagedto
reviewthefinancialstatementsof
HallCo.,anonissuer.Duringthe
engagementBakeruncovereda
complexschemeinvolvingclient
illegalactsthatmateriallyaffect
Hallsfinancialstatements.If
Bakerbelievesthatmodification
ofthestandardreviewreportis
notadequatetoindicatethe
deficienciesinthefinancial
statements,Bakershould
a. Disclaimanopinion.
b. Issueanadverseopinion.
c. Withdrawfromtheengagement.
d. Issueaqualifiedopinion.
30. Whichofthe followingis not
generally considered a
procedure followed by an
accountantinobtaininga
MODULE6ACCOUNTINGANDREVIEWSERVICES
d.
reasonablebasisfortheexpressionof
limitedassuranceforareviewoffinancial
statements?
a. Applyanalyticalprocedures.
b. Assessfraudrisk.
c. Makeinquiriesofmanagement.
d. Obtain written representations
frommanagement.
34.Whichofthefollowinginquiryor
analyticalproceduresordinarilyis
performedinanengagementtoreviewa
nonissuersfinancialstatements?
31. Whichofthefollowingprocedureswouldan
accountantleastlikelyperformduringan
engagementtoreviewthefinancial
statementsofanonissuer?
a. Observing
the
safeguards over access
toanduseofassetsand
records.
b. Comparing
the
financial statements
with anticipated
resultsinbudgetsand
forecasts.
c. Inquiring
of
management about
actions taken at the
board of directors
meetings.
d. Studying
the
relationships
of
financial statement
elements expected to
conform to predictable
patterns.
32. Which of the following
procedures should an ac
countantperformduringan
engagement to review the
financial statements of a
nonissuer?
a.
b.
Communicating
significant deficiencies
discovered during the
assessment of control
risk.
Obtaining a clientrepresentation
letter from members of
management.
c. Sending
bank
confirmation letters to
the entitys financial
institutions.
d. Examining
cash
disbursements in the
subsequent period for
unrecordedliabilities.
33. Anaccountantshouldperform
analyticalproceduresduringan
engagementto
a.
b.
c.
Compilea
nonissuers
financialstatements
No
Yes
Yes
No
Reviewa
nonissuers
financialstatements
No
Yes
No
205
Yes
a.
b.
c.
d.
Salesreturnsandallowances.
Creditsales.
Salesofconsignedgoods.
Cashsales.
1.
Whenperformingan
engagementtoreviewa
nonissuersfinancialstatements,
anaccountantmostlikelywould
1 Confirm a
sample of
significant
accounts
receivable
balances.
2 Ask about actions
taken at board of
directorsmeetings.
3 Obtain an understanding of
internalcontrol.
4 Limit the distribution of the
accountantsreport.
3.
Whenprovidinglimited
assurancethatthefinancial
statementsofanonissuer
(nonpublicentity)requireno
materialmodificationstobein
accordancewithgenerally
acceptedaccountingprinciples,
theaccountantshould
the
standardreviewreportisnot
accounting principles
adequatetoindicatethe
of the industry in
deficiencies,theaccountantshould
which the entity
1 Withdraw from the
operates.
engagement and provide
4 Develop audit programs
todeterminewhetherthe
no
further services
entitys
financial
concerning these financial
statements are fairly
statements.
presented.
2 Informmanagementthatthe
Analyticalproceduresdesignedtotesttheac
countingrecordsbyobtainingcorroboratingaudit40.Smith,CPA,hasbeenaskedtoissue
areviewreporton
evidence.
purchasestransactions.
b. Inquiries concerning
36. Whichofthefollowingwouldthe
theentitysprocedures
accountantmostlikelyinvestigate
for recording and
duringthereviewoffinancial
summarizing
statementsofanonissuerif
transactions.
accountsreceivabledidnot
c. Analyticalprocedures
conformtoapredictablepattern
designedtotestmanage
duringtheyear?
mentsassertions
2.
a.
regardingcontinued
existence.
d.
Inquiriesoftheentitysattorney
concerning
contingent
liabilities.
c.
d.
41. Inreviewingthefinancial
statementsofanonissuer,an
accountantisrequiredtomodify
thestandardreportforwhichof
thefollowingmatters?
MODULE6ACCOUNTINGANDREVIEWSERVICES
206
a.
b.
c.
d.
Inabilitytoassess
theriskofmaterial
misstatement
duetofraud
Yes
Yes
No
No
42. Eachpageofanonissuers
financialstatementsreviewed
byanaccountantshould
includethefollowing
reference:
a. See Accompanying Accountants
Footnotes.
b. Reviewed, No Material
ModificationsRequired.
c. SeeAccountantsReviewReport.
d. Reviewed, No Accountants
AssuranceExpressed.
43. Financial statements of a
nonissuer that have been
reviewed by an accountant
shouldbeaccompaniedbya
reportstatingthatareview
a. Provides only limited
assurance that the
financialstatementsare
fairlypresented.
b.
Includesexamining,on
a test basis,
informationthatisthe
representation of
management.
c.
d.
45. Gole,CPA,isengagedtoreview
the20X8financialstatementsof
NorthCo.,anonissuer.
Previously,GoleauditedNorths
20X7financialstatementsand
expressedanunqualifiedopinion.
Goledecidestoincludeaseparate
paragraphinthe20X8review
reportbecauseNorthplansto
presentcomparativefinancial
statementsfor20X8and20X7.
Thisseparateparagraphshould
indicatethat
a. The20X8reviewreport
isintendedsolelyfor
theinformationof
managementandthe
boardofdirectors.
b. The 20X7 auditors
reportmay no longerbe
reliedon.
c. Noauditingprocedures
were performed after
the date of the 20X7
auditorsreport.
d. There are justifiable
reasonsforchangingthe
levelofservicefroman
audittoareview.
Discoveryofsignificant
deficienciesinthedesign
oftheentitys
internalcontrol
Yes
No
Yes
No
Consists principally of
inquiries of company
personnel
and
analytical procedures
applied to financial
data.
Does not contemplate obtaining
corroboratingevidentialmatteror
applying certain other procedures
ordinarily performed during an
audit.
46. Anaccountantsstandardreport
onareviewofthefinancial
statementsofanonissuershould
statethattheaccountant
a. Does not express an
opinionoranyformof
limited assurance on
the
financial
statements.
44. Anaccountantwhohadbegunan
auditofthefinancialstatements
ofanonissuerwasaskedto
changetheengagementtoa
reviewbecauseofarestrictionon
thescopeoftheaudit.Ifthereis
reasonablejustificationforthe
change,theaccountantsreview
reportshouldincludereferenceto
the
a.
b.
c.
d.
Scopelimitation
thatcausedthe
changedengagement
Yes
No
No
Yes
Original
engagement
thatwasagreedto
No
Yes
No
Yes
d.
b.
c.
d.
Isnotawareofany
material
modificationsthat
shouldbemadeto
thefinancial
statementsforthem
toconformwith
GAAP.
Obtained reasonable
assurance
about
whether the financial
statements are free of
material misstate
ment.
Examinedevidence,on
atestbasis,supporting
theamountsand
disclosuresinthe
financialstatements.
47. Financialstatementsofa
nonissuerthathavebeenre
viewedbyanaccountantshould
beaccompaniedbyareport
statingthat
a. Thescopeoftheinquiry
andanalytical
proceduresperformed
bytheaccountanthas
notbeenrestricted.
b. Allinformation
includedinthe
financialstatementsis
therepresentationof
themanagementofthe
entity.
c. Areviewincludes
examining,onatest
basis,evidence
supportingtheamounts
anddisclosuresinthe
financialstatements.
Areviewisgreaterinscopethana
compilation,theobjectiveof
whichistopresentfinancialstate
mentsthatarefreeofmaterial
misstatements.
48. Duringareviewofthefinancial
statementsofanonissuer,an
accountantbecomesawareofa
lackofadequatedisclosurethat
ismaterialtothefinancial
statements.Ifmanagement
refusestocorrectthefinancial
statementpresentations,the
accountantshould
a. Issueanadverseopinion.
b. Issue an except for qualified
opinion.
c. Disclosethisdeparturefrom
generallyacceptedaccounting
principlesinaseparateparagraph
ofthereport.
d. Expressonlylimited
assurance on the
financial statement
presentations.
49. An accountant who reviews the
financial statements of a
nonissuer should issue a report
statingthatareview
a. Issubstantiallylessinscopethan
anaudit.
b. Provides
negative
assurance that internal
controlisfunctioningas
designed.
c. Provides only limited
assurance that the
financialstatementsare
fairlypresented.
d. Issubstantiallymoreinscopethan
acompilation.
MODULE6ACCOUNTINGANDREVIEWSERVICES
SIMULATIONS
TaskBasedSimulation1
Research
Authoritative
Literature
Help
Auditorswhoauditpublicnonpubliccompaniesmustbefamiliarwithprofessional
standardsdevelopedbyavarietyofsources.Foreachofthetypesofservicesbelowindicate
thepropersourceofprofessionalrequirements.Eachsourcemaybeusedonce,morethan
once,ornotatall.
S
o
A.
Acc
B.
Aud
C.
PC
1.
2.
A
A
3.
4.
A
A
5.
6.
7.
8.
9.
A
A
A
207
TaskBasedSimulation2
Research
Authoritative
Literature
Help
ReviewReports
ThepresidentofEnrightCorporation,anonpublicclient,askedyoutoperformareviewof
thefinancialstatementsforthecurrentyearonly.Youhavenowcompletedyourinquiryand
otherreviewproceduresandfindthatyoucanissueastandardreviewreport.
Selections
A. AU
B. PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
(A)(B)(C)(D)(E)(F)(G)(H)
1. WhichtitleoftheProfessionalStandardspresentsastandardreviewreport
ononeyear?
2. Entertheexactsectionandparagraphwiththeneededinformation.
MODULE6ACCOUNTINGANDREVIEWSERVICES
208
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
7.
8.
9.
d
c
c
d
a
d
d
d
b
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
10.
11.
12.
13.
14.
15.
16.
17.
18.
c
a
a
a
b
b
a
a
d
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
19.
20.
21.
22.
23.
24.
25.
26.
27.
a
c
b
b
d
a
a
a
b
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
28.
29.
30.
31.
32.
33.
34.
35.
36.
b
c
b
a
b
d
b
b
b
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
37.
38.
39.
40.
41.
42.
43.
44.
45.
MULTIPLECHOICEANSWEREXPLANATIONS
CompilationandReviewGeneral
1.
(d)Therequirementistoidentify
theengagementforwhich
StatementsonStandardsfor
AccountingandReviewServices
establishstandardsand
b
a
c
c
d
c
c
c
c
procedures.Answer(d)iscorrect
becausetheStatementsapply
whenaCPAeithercompilesor
reviewsthefinancialstatementsof
anonissuer.Answer(a)is
incorrectbecausetheStatements
donotapplywhentheCPAis
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
46.
47.
48.
49.
b
b
c
a
__
__
__
__
__
__
__
__
1st:__/49=__%
2nd:__/49=__%
assistinginadjustingthebooksof
accountforapartnershiporother
organization.
Answer(b)isincorrectbecausethe
Statementsonlyapplytononissuer
(nonpublic)entities.Answer(c)isincorrect
becausetheStatementsdonotapplywhen
processingthefinancialdataforclientsof
otheraccountingfirms.
2.
(c)Therequirementistoidentifythe
authoritativebodydesignatedtopromulgate
standardsconcerninganaccountants
associationwithunauditedfinancial
statementsofanentitythatisnotrequiredto
filefinancialstatementswithanagency
regulatingtheissuanceoftheentitys
securities.Answer(c)iscorrectbecausethe
AccountingandReviewServices
Committeeissodesignated.Answer(a)is
incorrectbecausetheFinancialAccounting
StandardsBoardistheauthoritativebody
designatedtopromulgatefinancial
accountingstandards.Answer(b)is
incorrectbecauseGovernment
AccountabilityOfficeisnotoneofthe
bodiesdesignatedbytheAICPAto
promulgatetechnicalstandards.Answer(d)
isincorrectbecausetheAuditingStandards
Boardistheauthoritativebodydesignatedto
promulgatestatementsonauditing
standards.ETAppendixApresentsthe
bodiesdesignatedtopromulgatetechnical
standards.
7.
(c)Therequirementisto
determinewhichofthetwo
listedaccountingservicesan
accountantmayperform
withoutbeingrequiredtoissuea
compilationorreviewreportunderthe
StatementsonStandardsforAccountingand
ReviewServices.Answer(c)iscorrect
becausetheStatementsonStandardsfor
AccountingandReviewServicesdonot
applytopreparingaworkingtrialbalanceor
topreparingstandardmonthlyjournal
entries.SeeSSARSfortheseandadditional
circumstancesinwhichthestandardsdonot
apply.Accordingly,nocompilationor
reviewreportneedstobeissuedwhenthese
servicesareprovided.
3.
5.(a)Therequirementistodeterminethe
correctstatementconcerningbothan
engagementtocompileandanengagement
toreviewanonissuersfinancial
statements.Answer(a)iscorrectbecause
neitheracompilationnorareview
contemplatesobtaininganunderstandingof
internalcontrol.Answer(b)isincorrect
becausewhenperformingacompilationthe
accountantneednotbeindependent;
independenceisrequiredforreviews.
Answer(c)isincorrectbecauseareview
provideslimitedassurance.Answer(d)is
incorrectbecausetheaccountantisnot
requiredtoobtainawrittenmanagement
representationletterforacompilation;a
managementrepresentationletteris
requiredforareview.
CompilationGeneral
6.
(d)Therequirementisto
determinewhetherreproducing
clientpreparedfinancial
statementswithoutmodification
andpreparingstandardmonthly
journalentriesareincludedinthe
provisionsofStatementson
StandardsforAccountingand
ReviewServices.Answer(d)is
correctbecauseAR100allows
theseservicesaslongastheac
countantsnameisnotassociated
withthefinancialstatements.
(d)Therequirementistoidentifythe
correctstatementaboutunauditedpersonal
financialstatementsincludedinapersonal
financialplan.Answer(d)iscorrectbecause
AT600requiresthatthefinancial
statementsbeusedsolelytoassisttheclient
andtheclientsadvisorandnotbeusedto
obtaincredit.Answer(a)isincorrect
becausefinancialstatementsmaybe
presentedincomparativeform.Answer(b)
isincorrectbecauseomitteddisclosuresmay
bematerial.Answer(c)isincorrectbecause
suchfinancialstatementsmaybedisclosed
toanonCPAfinancialplanner.
8.
(d)Therequirementistoidentify
thecircumstanceinwhich
StatementsonStandardsfor
AccountingandReviewServices
apply.TheStandardsapplywhen
aCPAsubmitsunauditedfinancial
statementsofanonissuer(non
public)entitytohisorherclient
orothers.Accordingly,answer(d)
iscorrect.Answers(a),(b),and
(c)areallincorrectbecausethey
areallincludedasservicesthatdo
notconstituteasubmissionof
financialstatementstoaclient.
9.
(b)Therequirementisto
determinewhethereitherorboth
of(1)theadditionalauditeffort
Answer(d)iscorrectbecauseanaccountant
mayaccepteitheracompilationorareview
engagementinsuchcircumstances.
necessarytocompletetheaudit
and(2)thereasonforthechange
intheengagementshouldbe
consideredbyaCPAwhose
clienthasrequestedthatanaudit
engagementbechangedtoa
compilation.Answer(b)is
correctbecauseSSARSstates
thatadditionalnecessaryaudit
effortandthereasonforthe
MODULE6ACCOUNTINGANDREVIEWSERVICES
whentheplan
changeaswellastheadditional
costtocompletetheauditbe
considered.
10.(c)Therequirementistodetermine
whenaCPAmaycompileandbeassociated
withfinancialstatementsthatomit
disclosuresrequiredbyGAAP.Answer(c)
iscorrectbecausetheCPAmaycompile
suchfinancialstatementsprovidedthatthe
omissionofsubstantiallyalldisclosures(1)
isclearlyindicatedintheauditreportand
(2)isnot,totheCPAsknowledge,
undertakenwiththeintentionofmisleading
thosewhomightreasonablybeexpectedto
usethefinancialstatements.
CompilationProcedures
11. (a)Therequirementistodeterminean
accountantsresponsibilityrelatingto
knowledgeoftheclientsaccounting
principlesandpracticeswhenperforminga
compilation.Answer(a)iscorrectbecause
tocompilefinancialstatementsthe
accountantshouldpossessageneral
understandingofthenatureoftheentitys
businesstransactions,theformofits
accountingrecords,thestatedqualifications
ofitsaccountingpersonnel,theaccounting
basisonwhichthefinancialstatementsare
tobepresented,andtheformandcontentof
thefinancialstatements.Answer(b)is
incorrectbecausetheaccountantneednot
haveageneralunderstandingoftheentitys
controls.Answer(c)isincorrectbecauseno
suchconsiderationofriskfactorsis
envisionedinacompilation.Answer(d)is
incorrectbecausenosuchconsiderationof
internalcontrolawarenessofsenior
managementismade.
12. (a)Therequirementistoidentify
theprocedureanaccountant
ordinarilyperformsina
compilationengagementofa
nonissuer.Answer(a)iscorrect
becausetheaccountantisrequired,
ataminimum,toreadthefinancial
statementstoconsiderwhether
theyarefreefromobvious
materialerrors.
CompilationReporting
13. (a)Therequirementistoidentifya
conditionrequiredforan
accountanttosubmitawritten
personalfinancialplancontaining
unauditedfinancialstatementstoa
clientwithoutcomplyingwiththe
compilationandreview
requirementspresentedinSSARS.
Answer(a)iscorrectbecause
SSARSallowsuchanexception
209
(1)istobeusedtoassisttheclientandthe
clientsadvisorsindevelopingfinancial
goalsandobjectives,(2)willnotbeused
toobtaincredit,and(3)whennothing
comestotheaccountantsattentionthat
wouldleadhim/hertobelievethatthe
statementswillbeusedforcreditorfor
anyotherpurposes.Answer(b)isincorrect
becauseanyworkperformedontheprior
yearstatementsisnotapplicabletothe
statementsofthecurrentyear.Answer(c)
isincorrectbecausetheengagementletter
neednotacknowledgedeparturesfrom
GAAP.Answer(d)isincorrectbecauseno
assuranceisprovidedinsuchreports.
14. (b)Therequirementistoidentify
anaccountantsreporting
responsibilitywhenperforminga
compilationandheorshe
determinesthatagoingconcern
uncertaintyhasnotbeenproperly
disclosedbyaclient.Answer(b)is
correctbecausethisisadeparture
fromGAAPandresultsin
modificationofthereportsthird
paragraphandadditionofan
explanatoryparagraph.Answer(a)
isincorrectbecausetheinformation
ontheclientsabilitytocontinueas
agoingconcernshouldbeincluded
inthefinancialstatements;ifitis
not,adeparturefromGAAPexists.
Answer(c)isincor
rectbecauseadverseopinionsarenotissued
basedoncompilations.Answer(d)is
incorrectbecausequalifiedopinionsarenot
issuedbasedoncompilations.
15. (b)Therequirementistoidentify
thestatementthatshouldbe
includedinacompilationreport.
Answer(b)iscorrectbecause
compilationreportsindicatethat
theaccountantcompiledthe
financialstatementsinaccordance
withStatementsonStandardsfor
AccountingandReviewServices.
16. (a)Therequirementisto
determinehowaCPAshould
indicatethataclientscompiled
financialstatementswere
preparedinconformitywiththe
incometaxbasisofaccounting
whenthefinancialstatements
providenosuchdisclosure.
Answer(a)iscorrectbecauseif
thebasisofaccountingisnot
disclosedinthefinancial
statements,theaccountantshould
disclosethebasisinthe
compilationreport.Answer(b)is
incorrectbecauseeachpageofthe
financialstatementsshouldonly
includethereferenceSee
AccountantsCompilation
Report.Answer(c)isincorrect
becausetheauditorisnotrequired
toissueaspecialreport.SeeAU
623forinformationonspecial
reporting.Answer(d)isincorrect
becausetheauditordoesnothave
towithdrawfromthe
engagement.
17. (a)Therequirementisto
determinehowthecompilation
reportshouldbemodifiedto
indicatethattheentitysfinancial
statementsdonotincludeall
disclosuresrequiredbyGAAP.
Answer(a)iscorrectbecauseAR
100statesthatwhilethe
accountantmaycompilesuch
financialstatements,the
accountantmustclearlyindicate
inthecompilationreportthat
substantiallyalldisclosures
requiredbyGAAPhavebeen
omitted.Answer(b)isincorrect
becausethefinancialstatements
arenotcompiledonacomprehen
sivebasisotherthanGAAP.
Answer(c)isincorrectbecausea
compilationmaybeperformedon
financialstatementslackingsuch
disclosures.Answer(d)is
incorrectbecausethesefinancial
statementsarenotconsidered
specialpurposefinancial
statements.
18. (d)Therequirementisto
determinetheproperreporting
procedureforcomparative
financialstatementsforwhichthe
prioryearisunaudited,andthe
currentyearisaudited.AU504
statesthatwhenunaudited
financialstatementsarepresented
incomparativeformwithaudited
financialstatements,thereporton
thepriorperiodmaybereissued
toaccompanythecurrentperiod
report.Inaddition,thereporton
thecurrentperiodmayalso
includeaseparateparagraph
describingresponsibilityassumed
forthepriorperiodfinancial
statements.Ifthesestatementsare
filedwiththeSEC,thestatements
shouldbeclearlymarkedas
unauditedbutshouldnotbe
referredtointheauditorsreport.
19. (a)TherequirementistodetermineaCPAs
responsibilitywhenthefirstyearof
compiledcomparativefinancialstatements
omitsubstantiallyalldisclosuresrequired
bygenerallyacceptedaccountingprinciples,
whilethesecondyearsstatementsinclude
suchdisclosures.Answer(a)iscorrect
becausetheCPAmaynotreportonthe
comparativefinancialstatementsbecauseof
alackofcomparability.Answers(b),(c),
and(d)areallincorrectbecausetheyallow
suchreportingtooccurundercertain
circumstances.
210
MODULE6ACCOUNTINGANDREVIEWSERVICES
20. (c)Therequirementistoidentify
the statementthatshould not be
included in a CPAs financial
statement compilation report.
Answer (c) is correct because a
compilation report provides no
assurance on the financial
statements.
21. (b)Therequirementisto
determinetherepresentations
madeexplicitlyandimplicitly
whenissuingastandard
compilationreportona
nonissuersfinancialstatements.
Answer(b)iscorrectbecausethe
reportexplicitlystatesthatthe
financialstatementshavenotbeen
auditedandthattheaccountanthas
compiledthem.
appropriatecommunication
option(s)whencompiledfinancial
statementsareonlygoingtobeused
bymanagement.Answer(a)is
correctbecausewhenanac
countantsubmitstoaclient
compiledfinancialstatementsthat
arenotexpectedtobeusedbya
thirdparty,eitheracompilation
reportorawrittenengagementletter
(orboth)maybeused.Answer(b),
(c),and(d)areallincorrectbe
causetheysuggestthateithera
compilationreport,awritten
engagementletter,orbothare
unacceptable.
report.Answer(c)isincorrectbecausea
reviewreportmaynotbeissued.Answer
(d)isincorrectbecausetheCPAisnot
independent.
28. (b)Therequirementistoidentifythe
circumstanceinwhichaCPAmayissuea
reviewreportonasinglefinancial
statement.Answer(b)iscorrectbecausean
accountantmayissueareviewreportona
financialstatement,suchasabalancesheet,
andnotreportontheotherrelatedfinancial
statementsifthescopeofhisorherinquiry
andanalyticalprocedureshasnotbeen
restricted.Answer(a)isincorrectbecause
thebalancesheetneednotbepresentedin
prescribedform.Answer(c)isincorrect
becausethebalancesheetmaybeusedto
obtaincreditortodistributetocreditors.
Answer(d)isincorrectbecausespecialized
accountingprinciplesandpracticesinan
industrymayormaynotneedtobe
discloseddependinguponthe
circumstances.
29. (c)TherequirementistoidentifyaCPAs
responsibilitywhenheorshebelievesthat
modificationofthestandardreviewreport
isnotadequatetoindicatedeficienciesin
financialstatementsaffectedbyillegalacts.
Answer(c)iscorrectbecausewhenevera
CPAbelievesthatmodificationofthe
standardreportisnotadequatetoindicate
thedeficienciesinthefinancialstatements,
heorsheshouldwithdrawfromthereview
engagementandprovidenofurtherservices
withrespecttothosefinancialstatements.
ReviewProcedures
30. (b)Therequirementistoidentify
theprocedurenotfollowedbyan
accountantinobtaininga
reasonablebasisforthe
expressionoflimitedassurance
forareviewoffinancial
statements.Answer(b)iscorrect
becausereviewsordinarilydonot
includeanassessmentoftherisk
offraud.Answer(a)isincorrect
becausereviewsincludeanalytical
procedures.Answer(c)is
incorrectbecauseareviewin
cludesinquiriesofmanagement.
Answer(d)isincorrectbecause
auditorsobtainwritten
representationfrommanagement
whenperformingareview.
31. (a)Therequirementistoidentify
theprocedureleastlikelytobe
performedinareviewofthe
financialstatementsofa
nonissuer.Answer(a)iscorrect
becauseareviewofanonissuer
financialstatementsdoesnot
specificallyaddressobservingthe
safeguardsoveraccesstoanduse
ofassetsandrecords.Answers
(b),(c),and(d)areallincorrect
becausetheyareincludedinthe
proceduressuggestedforareview
bySSARS.
32. (b)Therequirementistoidentify
theproceduresthatanaccountant
wouldperformduringan
engagementtoreviewthe
financialstatementsofa
nonissuer.Answer(b)iscorrect
becauseAR100requiresthatthe
CPAobtainarepresentationletter.
Answers(a),(c),and(d)are
incorrectbecausetheyarenot
includedinSSARSwhichpresent
alistofproceduresperformed
duringareview.
33. (d)Therequirementisto
determinewhetheranalytical
proceduresneedtobeperformed
onacompilationand/orareview
engagement.Answer(d)iscorrect
becauseacompilationdoesnot
requireperformanceofanalytical
procedures,whileareviewdoes.
34. (b)Therequirementisto
determinethetypeofinquiryor
analyticalproceduresordinarily
performedinanengagementto
reviewanonissuersfinancial
statements.Answer(b)iscorrect
becauseanaccountantwillmake
MODULE6ACCOUNTINGANDREVIEWSERVICES
inquiriesconcerningtheentitysprocedures
forrecording,classifying,andsummarizing
transactions,andaccumulatinginformationfor
disclosureinthefinancialstatements.Answer
(a)isincorrectbecausetheanalytical
proceduresandotherproceduresinvolvedina
reviewdonotingeneralobtaincorroborating
auditevidenceasdotheproceduresofan
audit.Answer(c)isincorrectbecausethe
proceduresforreviewsarenotspecially
designedtotestmanagementsassertion
regardingcontinuedexistence.Answer(d)is
incorrectbecauseinquiriesoftheentitys
attorneyarenotnormallyrequiredwhena
reviewisbeingperformed.
35. (b)Therequirementisto
determinethemostlikely
procedurestobeincludedina
reviewengagementofanonissuer.
Answer(b)iscorrectbecausea
reviewconsistsprimarilyof
inquiriesandanalytical
procedures.Answer(a)isincorrect
becauseabanktransferscheduleis
generallynotpreparedforareview
engagement.Answer(c)is
incorrectbecauseareviewdoes
notincludeassessingthecontrol
structure.Answer(d)isincorrect
becausecutofftestsonsalesand
purchasesarenotnormally
performedonareview.Notethat
theproceduresincludedinanswers
(a),(c),and(d)aretypically
performedinanaudit.
36. (b)Therequirementistodeterminethetype
oftransactiontheaccountantismostlikely
toinvestigateduringareviewwhenthe
yearsaccountsreceivabledidnotconform
toapredictablepattern.Answer(b)is
correctbecauseaccountsreceivableare
generatedfromcreditsalesandan
accountantwouldthereforeinvestigatethem.
Answer(a)isincorrectbecausesales
returnsandallowanceswouldbelesslikely
tocauselargeshiftsinaccountsreceivable
thancreditsales.Answer(c)isincorrect
becauseitislesscompletethananswer(b)
sincesalesofconsignedgoodsrepresent
onlyonepossibletypeofsalethatmight
impactaccountsreceivable.Answer(d)is
incorrectbecausecashsalesdonotaffect
accountsreceivable.
37. (b)Therequirementistoidentify
themostlikelyproceduretobe
includedinareviewofa
nonissuersfinancialstatements.
Answer(b)iscorrectbecause
SSARSstatethatreviews
ordinarilyincludeinquires
concerningactionstakenatboard
ofdirectorsmeetings.Answer(a)
211
isincorrectbecausereviews
consistprimarilyofinquiryand
analyticalproceduresanddonot
generallyincludeconfirmationof
accountsreceivable.Answer(c)is
incorrectbecauseareviewofa
nonpublicentitydoesnot
normallyincludeobtainingan
understandingofinternalcontrol
orassessingcontrolrisk.Answer
(d)isincorrectbecausedistri
butionofareviewreportneednot
belimited.SeeSSARSfor
specificproceduresincludedin
reviews.
ReviewReporting
38.(a)Therequirementistodeterminea
CPAsresponsibilitieswhenperforminga
reviewofanonissuersfinancialstatements
thatcontainuncorrecteddeparturesfrom
GAAPandtheCPAbelievesthatthereview
reportisnotadequatetoindicatethe
deficiencies.Answer(a)iscorrectbecause
SSARSstatethatinsuchcircumstancesthe
CPAshouldwithdrawfromtheengagement
andprovidenofurtherserviceswithrespect
tothosefinancialstatements.Answers(b)
and(d)areincorrectbecauserestricting
distributionisnotadequateorappropriate
insuchacircumstance.Answer(c)is
incorrectbecausethestandardsonspecial
reportsdonotapplyinthiscircumstance.
39. (c)Therequirementisto
determinethelistedrequirement
whenanaccountantisproviding
limitedassurancethatthe
financialstatementsofanonissuer
requirenomaterialmodifications
tobeinaccordancewithgenerally
acceptedaccountingprinciples.
Accountantsperformreviewsto
providesuchlimitedassurance.
Answer(c)iscorrectbecause
obtaininganunderstandingofthe
accountingprinciplesinthe
industryisrequiredforreviews.
SeeSSARSforthisandother
requirements.Answer(a)is
incorrectbecausereviewsdonot
requiretheaccountanttoassessthe
riskofmaterialmisstatement.
Answer(b)isincorrectbecause
reviewsgenerallydonotinclude
anycommunicationwiththe
entityslawyer.Answer(d)is
incorrectbecauseanaudit
programisnotrequiredsincea
reviewisbeingperformed.
40. (c)Therequirementistoidentifythe
circumstancesinwhichaCPAmayissuea
reviewreportonthebalancesheetofa
nonissuer,andnotreportontherelated
financialstatements.Answer(c)iscorrect
becauseanaccountantmayissueareview
reportononefinancialstatementandnoton
theotherrelatedstatementsifthescopeof
theinquiryandanalyticalprocedureshasnot
beenrestricted.
Answer(a)isincorrectbecausetheCPA
neednotcompileorreportontherelated
statementsofincome,retainedearnings,and
cashflowswhenreviewingonlythebalance
sheet.Answer(b)isincorrectbecause,when
materialmodificationsareneeded,aCPA
maystillreportonthebalancesheet,but
mustindicatethemodificationsinthe
reviewreport.Answer(d)isincorrect
becausetheclientneednotbenew.
41. (d)Therequirementistoidentify
whetherareviewreportismodified
duetoeitherinabilitytoassessthe
riskofmaterialmisstatementdueto
fraud,adiscoveryofinternalcontrol
deficiencies,orboth.Answer(d)is
correctbecauseneitherofthese
circumstancesrequiresmodification
ofareviewreport.Answers(a),(b),
and(c)areallincorrectbecause
theysuggestthatoneortheotherof
thesecircumstancesresultsin
modificationofareviewreport.A
departurefromGAAPisthe
primarycauseofareviewreport
modification.SSARSprovide
guidanceonreviewreports.
42. (c)Therequirementistoidentify
thereferencethatshouldbe
includedineachpageofa
nonissuersreviewedfinancial
statements.SSARSrequirethat
eachpageofthefinancial
statementsincludeareference
suchasSeeAccountants
ReviewReport.
43. (c)Therequirementistoidentify
thestatementthatisincludedinan
accountantsreviewreportonthe
financialstatementsofa
nonissuer.Answer(c)iscorrect
becauseareviewreportincludesa
statementthatareviewconsists
principallyofinquiresofcompany
personnelandanalytical
proceduresappliedtofinancial
data.SeeSSARSforinformation
thatshouldbeincludedina
reviewreport.
44. (c)Therequirementistodetermine
aCPAsreportingresponsibility
whenanauditengagementfora
nonissuerhasbeenchangedtoa
reviewengagementbecauseofwhat
theCPAbelievestobeareasonable
restrictiononthescopeoftheaudit.
Answer(c)iscorrectbecausein
suchcircumstancestheCPAshould
neitherincludereferencetothe
originalengagementnortothe
scopelimitation.
45. (c)Therequirementistoidentify
thecorrectstatementrelatingto
a CPAs report on comparative
statements
212
MODULE6ACCOUNTINGANDREVIEWSERVICES
whenthecurrentyearhasbeenreviewedandtheprevious
yearhasbeenaudited.Answer(c)iscorrectbecausewhena
separateparagraphisbeingaddedtotheCPAsreviewre
porttheCPAshouldclearlyindicatethedifferenceinthe
levelsofassuranceforthetwoyears.Inthissituation,
SSARSrequiretheauditortoindicatethattheprevious
yearsfinancialstatementswereaudited,thedateofthere
port,thetypeofopinionexpressedandiftheopinionwas
otherthanunqualified,thesubstantivereasonsforthat
opinion,andthatnoauditingprocedureswereperformed
afterthedateofthepreviousreport.Answer(a)isincorrect
becausethereviewreportisnotsolelyintendedforman
agementortheboardofdirectors.Answer(b)isincorrect
becausetheprioryearsauditreportmaystillbeappropriate.
Answer(d)isincorrectbecausethisstatementdoesnotneed
tobeincludedwithinthereviewreport.
46. (b)Therequirementistoidentifythestatement
includedinthestandardreportissuedbyan
accountantafterreviewingthefinancial
statementsofanonissuer.Answer(b)iscorrect
becausethereportstatesthattheaccountantis
notawareofanymaterialmodificationsthat
should
bemadetothefinancialstatementsinorderforthemtobein
conformitywithgenerallyacceptedaccountingprinciples.
SSARSpresenttherequireddisclosuresforareviewreport.
47. (b)Therequirementistoidentifytheinformation
presentedinareviewreportoffinancialstatements
ofanonissuer.Answer(b)iscorrectbecausethe
reportindicatesthatallinformationincludedinthe
financialstatementsistherepresentationofthe
managementoftheentity.
48. (c)Therequirementistodeterminean
accountantsreportingresponsibilitywhen
associatedwithanonissuersreviewedstatements
whichcontainamaterialdeparturefromgenerally
acceptedaccountingprinciples.Answer(c)is
correctbecauseSSARSrequiretheinclusionofa
separateparagraphdescribingthedeparture.
Answers(a)and(b)areincorrectbecausean
adverseopinionoranexceptforqualified
opinionmayonlybeissuedwhenanaudithasbeen
performed.Answer(d)isincorrectbecause
expressinglimitedassurance(asisnormally
providedinreviews)onthefinancialstatementsis
notadequatetodisclosethedeparture.
49. (a)Therequirementistoidentifythereplywhich
is correct concerning the content of a review
report.An
swer(a)iscorrectbecauseareviewreportindicatesthata
reviewissubstantiallylessinscopethananaudit.Answer(b)
isincorrectbecauseareviewreportprovidesnoinformationon
internalcontrol.Answer(c)isincorrectbecausewhileareview
reportstatesthattheaccountantisnotawareofanymaterial
modificationsthatshouldbemadetothefinancialstatements,it
doesnotprovidelimitedassurancethatthefinancial
statementsarefairlypresented.An
swer(d)isincorrectbecausewhileareviewreportdoesstate
thatareviewissubstantiallylessinscopethananaudit,it
doesnotrefertoacompilation.
MODULE6ACCOUNTINGANDREVIEWSERVICES
S
O
T
R
e
A
u
L
i
1.
2.
3.
4.
A
A
A
A
5.
6.
7.
8.
A
A
9.
213
T
Research
Authoritative
Literature
1.
2.
W
h
E
MODULE7AUDITSAMPLING
214
AUDITSAMPLING
MULTIPLECHOICEQUESTIONS(1
58)
1.
Anadvantageofusing
statisticalover
nonstatisticalsampling
methodsintestsof
controlsisthatthe
statisticalmethods
a. Can more
easily convert
thesampleinto
a dualpurpose
test useful for
substantive
testing.
b. Eliminate the
need to use
judgment in
determining
appropriate
samplesizes.
c. Afford greater
assurance than a
nonstatisticalsam
pleofequalsize.
d. Provide
an
objectivebasisfor
quantitatively
evaluatingsample
risk.
2.
An advantage of statistical
sampling over nonstatistical
sampling is that statistical
samplinghelpsanauditorto
a.
d.
3.
The likelihood of
assessing control risk too
high is the risk that the
sample selected to test
controls
a. Doesnotsupport
theauditors
plannedassessed
levelofcontrol
riskwhenthetrue
operatingeffec
tivenessofthe
controlstructure
b.
c.
d.
4.
a.
b.
c.
d.
5.
c.
justifiessuchan
assessment.
Contains
misstatementsthat
couldbematerial
tothefinancial
statementswhen
aggregatedwith
misstatementsin
otheraccount
balancesor
transactions
classes.
Contains
proportionately
fewermonetary
errorsor
deviationsfrom
prescribed
controlsthanexist
inthebalanceor
classasawhole.
Does not support
the tolerable error
forsomeorallof
managements
assertions.
audit
proceduresthatare
not appropriate to
achieve
the
specificobjective.
An auditor may fail to
recognizeerrorsinthedocu
ments examined for the
chosensample.
d. The documents
related to the
chosen sample
may not be
available for
inspection.
6.
a.
b.
c.
d.
In assessing sampling
risk,theriskofincorrect
rejectionandtheriskof
assessingcontrolrisktoo
highrelatetothe
Efficiencyoftheaudit.
Effectivenessoftheaudit.
Selectionofthesample.
Auditqualitycontrols.
Items7and8arebasedonthe
followinginformation:
Thediagrambelowdepictsthe
auditorsestimateddeviationrate
comparedwiththetolerablerate,
andalsodepictsthetruepopulation
deviationratecomparedwiththe
tolerablerate.
TrueStateof
Population
Deviationrate
Deviationrateis
exceedstolerable
lessthantolerable
rate
rate
Auditors
estimate
basedon
sampleresults
Deviationrate
exceeds
tolerable
rate
Deviationrate
islessthan
tolerable
rate
7.
a.
b.
c.
d.
8.
a.
b.
c.
d.
9.
a.
b.
c.
d.
I.
II.
III.
IV.
Inwhichofthesituations
wouldtheauditorhave
properlyconcludedthat
controlriskisatorbelow
theplannedassessedlevel?
I.
II.
III.
IV.
Asaresultoftestsof
controls,theauditor
assessescontrolrisktoo
highandtherebyincreases
substantivetesting.Thisis
illustratedbysituation
I.
II.
III.
IV.
Whileperformingatestof
detailsduringanaudit,an
auditordeterminedthatthe
sampleresultssupported
theconclusionthatthe
recordedaccountbalance
wasmateriallymisstated.It
was,infact,notmaterially
misstated.Thissituation
illustratestheriskof
Assessing control risk too
high.
Assessing control risk too
low.
Incorrectrejection.
Incorrectacceptance.
a.
b.
c.
Thelargerofthe
samplesthat
wouldotherwise
havebeen
designedforthe
twoseparate
purposes.
Thesmallerofthe
samplesthat
wouldotherwise
havebeen
designedforthe
twoseparate
purposes.
Thecombined
totalofthe
d.
samplesthat
wouldotherwise
havebeen
designedforthe
twoseparate
purposes.
Morethanthelargerofthe
samplesthatwouldoth
erwisehavebeendesignated
forthetwoseparate
purposes,butlessthanthe
combinedtotalofthe
samplesthatwould
otherwisehavebeen
designedforthetwo
separatepurposes.
MODULE7AUDITSAMPLING
11. The expected population
deviation rate of client
billing errors is 3%. The
auditor has established a
tolerablerateof5%. In the
reviewofclientinvoicesthe
auditorshoulduse
a.
b.
c.
d.
Stratifiedsampling.
Variablesampling.
Discoverysampling.
Attributesampling.
12. Whichofthefollowing
samplingmethodswould
beusedtoestimatea
numericalmeasurementof
apopulation,suchasa
dollarvalue?
a. Attributesampling.
b. Stoporgosampling.
c. Variablessampling.
d. Randomnumbersampling.
13. Forwhichofthefollowing
audittestswouldanauditor
most likely use attribute
sampling?
a. Making an independent
estimateoftheamountofa
LIFOinventory.
b. Examining
invoices in
support of the
valuation of
fixed asset
additions.
c. Selecting
accounts
receivable for
confirmation of
account
balances.
d. Inspecting
employee
timecardsfor
proper ap
proval by
supervisors.
14. An underlying feature
of
randombased
selectionofitemsisthat
each
a. Stratum of
the
accounting
population be
given equal
representation
inthesample.
b. Item in the
accounting
population be
randomly or
dered.
c.
d.
215
Item in the
accounting
population
should have an
opportunitytobe
selected.
Item must be
systematically
selected using
replacement.
selection
techniques is
least
desirable for use by an
auditor?
a. Systematicselection.
b. Stratifiedselection.
c. Blockselection.
d. Sequentialselection.
16. Which of the following
statistical sampling plans
does not use a fixed
sample size for tests of
controls?
a. Dollarunitsampling.
b. Sequentialsampling.
c. PPSsampling.
d. Variablessampling.
17. If certain forms are not
consecutivelynumbered
a. Selection of a
random sample
probably is not
possible.
b. Systematicsamplingmaybe
appropriate.
c. Stratified sampling should
beused.
d. Random number tables
cannotbeused.
18. Whenperformingatestof
acontrolwithrespectto
controlovercashreceipts,
anauditormayusea
systematicsampling
techniquewithastartat
anyrandomlyselected
item.Thebiggest
disadvantageofthistype
ofsamplingisthatthe
itemsinthepopulation
a. Must
be
systematically
replaced in the
population after
sampling.
b.
c.
d.
May
systematically
occur more
thanonceinthe
sample.
Must be recorded
in a systematic
pattern before the
sample can be
drawn.
May occur in a
systematic
pattern, thus
destroying the
sample
randomness.
d.
21. Whichofthefollowing
factors
is(are)
considered
in
determining the sample
size for a test of
controls?
a.
b.
c.
d.
Expected
deviationrate
Yes
No
No
Yes
Tolerable
deviationrate
Yes
No
Yes
No
the
sampleselected.
populationsize
b. To determine the
doubles, the
occurrence rate
sample size
for a given char
should also
acteristic in the
double.
population being
c. The qualitative
studied.
aspects
of
c. To decrease the effect of
deviations are
variance in the total popu
lation.
not considered
d. To determine the
bytheauditor.
precisionrangeof
d. There is an
the sample se
inverse
lected.
relationship
betweenthesam
20. Asaresultoftestsof
ple size and the
controls,anauditor
tolerablerate.
assessedcontrolrisktoo
lowanddecreased
23. Indeterminingthesample
substantivetesting.This
sizeforatestofcontrols,
assessmentoccurred
anauditorshouldconsider
becausethetruedeviation
thelikelyrateof
rateinthepopulationwas
deviations,theallowable
a. Less than the risk
riskofassessingcontrol
of assessing
risktoolow,andthe
control risk too
a. Tolerabledeviationrate.
low, based on the
b. Risk of incorrect
auditorssample.
acceptance.
b. Lessthanthedeviationratein
c. Nature and cause of
theauditorssample.
deviations.
c. More than the
d. Populationsize.
risk
of
24. Which of the following
assessing
combinationsresultsina
control risk
decreaseinsamplesize
toolow,based
in a sample for
on
the
auditors
attributes?
sample.
a.
b.
Riskof
assessing
controlrisk
toolow
Increase
Decrease
c.
d.
Increase
Increase
216
Tolerable
rate
Decrease
Increase
Increase
Increase
25. Anauditoristestinginternalcontrol
proceduresthatareevidencedonan
entitysvouchersbymatching
randomnumberswithvoucher
numbers.Ifarandomnumber
matchesthenumberofavoided
voucher,thatvoucherordinarily
shouldbereplacedbyanother
voucherintherandomsampleifthe
voucher
a. Constitutesadeviation.
b. Hasbeenproperlyvoided.
c. Cannotbelocated.
d. Represents an immaterial
dollaramount.
26. Anauditorplanstoexamine
asampleoftwentypur
chaseordersforproper
approvalsasprescribedby
theclientscontrol
procedures.Oneofthe
purchaseordersinthe
chosensampleoftwenty
cannotbefound,andthe
auditorisunabletouse
alternativeproceduresto
testwhetherthatpurchase
orderwasproperly
approved.Theauditor
should
a. Choose another
purchase order to
replace the miss
ingpurchaseorder
inthesample.
b. Considerthistest
ofcontrolinvalid
andproceedwith
substantivetests
sinceinternal
controlcannotbe
reliedupon.
c. Treat the missing
purchase order as
adeviationforthe
purpose
of
evaluating the
sample.
d. Select
a
completely new
set of twenty
purchaseorders.
27. Whenassessingthe
tolerablerate,theauditor
shouldconsiderthat,while
Expected
population
deviationrate
Increase
Decrease
MODULE7
AUDITSAMPLING
d.Unrelatedtotheexpectedrateoferrorsinthere
latedaccountingrecords.
deviationsfromcontrol
proceduresincreasethe
riskofmaterial
misstatements,such
deviationsdonot
necessarilyresultinerrors.
Thisexplainswhy
a. Arecorded
disbursement
thatdoesnot
showevidence
ofrequired
approvalmay
neverthelessbea
transactionthat
isproperly
authorizedand
recorded.
b. Deviationswould
resultinerrorsin
theaccounting
recordsonlyifthe
deviationsandthe
errorsoccurred
ondifferent
transactions.
c. Deviationsfrom
pertinentcontrol
proceduresata
givenrate
ordinarilywould
beexpectedto
resultinerrorsata
higherrate.
d. A recorded
disbursement
that is properly
authorized may
nevertheless be
a transaction
that contains a
materialerror.
Decrease
Increase
c.
error.
Estimate the reliability of
substantivetests.
d. Estimate the
range
of
procedural
deviations in the
population.
30. Iftheauditorisconcerned
thatapopulationmaycon
tainexceptions,the
determinationofasample
sizesufficienttoincludeat
leastonesuchexceptionisa
characteristicof
a.
b.
c.
d.
Discoverysampling.
Variablessampling.
Randomsampling.
Dollarunitsampling.
31. Indeterminingthenumber
ofdocumentstoselectfora
testtoobtainassurancethat
allsaleshavebeenproperly
authorized,anauditor
shouldconsiderthe
tolerablerateofdeviation
fromthecontrolactivity.
Theauditorshouldalso
considerthe
I. Likelyrateofdeviations.
AI. Allowableriskofassessingcontrol
risktoohigh.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
EitherIorII.
Anauditorshouldconsiderthetolerable
rateofdeviationwhendeterminingthe
numberofcheckrequeststoselectfor
atesttoobtainassurancethatallcheck
requestshavebeenproperlyauthorized.
Theauditorshouldalsoconsider
a.
b.
c.
d.
Theaveragedollarvalue
ofthecheckrequests
Yes
Yes
No
No
Theallowable
riskofassessing
controlrisktoolow
Yes
No
Yes
No
33. Whichofthefollowingstatementsis
correct concerning statistical
samplingintestsofcontrols?
a. As
the
population size
increases, the
sample size
should increase
proportionately.
b. Deviationsfrom
specificinternal
controlproce
duresatagiven
rateordinarily
resultin
misstatements
atalowerrate.
c. There is an
inverse
relationship
between the
expected
population
d.
deviation rate
andthesample
size.
In determining
tolerable rate, an
auditor considers
detection risk
and the sample
size.
34. Whatisanauditors
evaluationofastatistical
sampleforattributeswhen
atestoffiftydocuments
resultsinthreedeviations
iftolerablerateis7%,the
expectedpopulation
deviationrateis5%,and
theallowancefor
samplingriskis2%?
a. Modifythe
plannedassessed
levelofcontrol
riskbecausethe
tolerablerateplus
theallowancefor
samplingrisk
exceedsthe
b.
c.
expected
populationde
viationrate.
Acceptthe
sampleresultsas
supportforthe
plannedassessed
levelofcontrol
riskbecausethe
sampledeviation
rateplusthe
allowancefor
samplingrisk
exceedsthe
tolerablerate.
Acceptthesample
resultsassupport
fortheplanned
assessedlevelof
controlrisk
becausethe
tolerablerateless
theallowancefor
samplingrisk
equalsthe
expected
population
deviationrate.
MODULE7AUDITSAMPLING
d.
Items35and36arebasedonthe
following:
Anauditordesiredtotest
creditapprovalon10,000sales
invoicesprocessedduringthe
year.Theauditordesigneda
statisticalsamplethatwould
provide1%riskofassessing
controlrisktoolow(99%
confidence)thatnotmorethan7%
ofthesalesinvoiceslacked
approval.Theauditorestimated
frompreviousexperiencethat
about
21/2%ofthesalesinvoiceslacked
approval.Asampleof200invoices
wasexaminedand7ofthemwere
lackingapproval.Theauditorthen
determinedtheachievedupper
precisionlimittobe8%.
35. Intheevaluationofthis
sample,theauditor
decidedtoincreasethe
levelofthepreliminary
assessmentofcontrolrisk
becausethe
a. Tolerable rate
(7%) was less
than the achieved
upper precision
limit(8%).
b. Expected
deviation rate
(7%)wasmore
than
the
percentage of
errors in the
sample (3
1/2%).
c.
Achieved
upperprecision
limit(8%)was
more than the
percentage of
errors in the
sample
(31/2%).
d. Expected
deviation rate (2
1/2%) was less
than the tolerable
rate(7%).
36. Theallowanceforsamplingrisk
was
a. 51/2%
b.
c.
d.
41/2%
31/2%
1%
217
37. Whichofthefollowingstatementsis
correct concerning statistical
samplingintestsofcontrols?
a. Thepopulation
sizehaslittleor
noeffectondeter
miningsample
sizeexceptfor
verysmallpopula
tions.
b. Theexpected
population
deviationratehas
littleornoeffect
ondetermining
samplesizeexcept
forverysmall
populations.
c. As
the
populationsize
doubles, the
sample size
also should
double.
d. Foragiven
tolerablerate,a
largersample
sizeshouldbe
selectedasthe
expected
populationde
viationrate
decreases.
38. When an auditor has
chosenarandomsample
and is using
nonstatistical attributes
sampling,thatauditor
a. Need notconsider
the risk of
assessing control
risktoolow.
b. Has committed a
nonsamplingerror.
c. Will have to
use discovery
sampling to
evaluate the
results.
d. Should compare
the deviation rate
of the sample to
the tolerable
deviationrate.
39. Howwouldincreasesin
tolerablemisstatementand
assessedlevelofcontrol
riskaffectthesamplesize
inasubstantivetestof
details?
Increaseintolerable
Increaseinassessed
a.
b.
misstatement
Increasesamplesize
Increasesamplesize
levelofcontrolrisk
Increasesamplesize
c.
Decreasesamplesize
Decreasesamplesize
d.
Decreasesamplesize
Increasesamplesize
Decreasesamplesize
40. Whichofthefollowing
coursesofactionwouldan
auditormostlikelyfollow
inplanningasampleof
cashdisbursementsifthe
auditorisawareofseveral
unusuallylargecash
disbursements?
a. Set the tolerable
rateofdeviation
at a lower level
than originally
planned.
b.
c.
Increase the
sample size to
reduce the effect
of the unusually
large
disbursements.
d.
Continue to draw
new samples until
all the unusually
large
disbursements
appear in the
sample.
a.
b.
c.
d.
Expected
amountof
misstatements
No
Yes
No
Yes
42. Whenplanningasample
forasubstantivetestof
details,anauditorshould
considertolerable
misstatementforthe
sample.This
considerationshould
a. Be related to the auditors
businessrisk.
b. Not be adjusted for
qualitativefactors.
c. Be related to
preliminary
judgments about
materiality
levels.
Measureof
tolerable
misstatement
No
Yes
Yes
No
d.
c.
thepopulation.
Theacceptablelevelofrisk.
d. The estimated
rate
of
misstatements in
thepopulation.
43. Anumberoffactors
influencesthesamplesize
forasubstantivetestof
detailsofanaccount
balance.Allotherfactors
45. Anauditorestablisheda$60,000
beingequal,whichofthe
tolerablemisstatementforanasset
followingwouldleadtoa
withanaccountbalanceof
largersamplesize?
$1,000,000.Theauditorselecteda
a. Greaterrelianceoninternal
sampleofeverytwentiethitemfrom
control.
thepopulationthatrepresentedthe
assetaccountbalanceanddiscovered
b. Greater reliance on
overstatementsof$3,700and
analyticalprocedures.
understatementsof$200.Underthese
c. Smallerexpectedfrequency
circumstances,theauditormostlikely
oferrors.
wouldconcludethat
d. Smaller measure of
a. Thereisan
tolerablemisstatement.
unacceptablyhigh
riskthattheactual
misstatementsin
thepopulation
exceedthetoler
ablemisstatement
becausethetotal
projectedmis
statementismore
thanthetolerable
misstatement.
44. Inestimationsamplingfor
variables, which of the
followingmustbeknown
in order to estimate the
appropriate sample size
required to meet the
auditorsneedsinagiven
situation?
a. The qualitative aspects of
errors.
b. The total dollar amount of
218
MODULE7
b.
b.
c.
d.
Thereisan
unacceptablyhigh
riskthatthetoler
ablemisstatement
exceedsthesumof
actualover
statementsand
understatements.
Theassetaccount
isfairlystated
becausethetotal
projected
misstatementis
lessthanthe
tolerable
misstatement.
Theassetaccountis
fairlystatedbecause
the
tolerable
misstatement
exceeds the net of
projected actual
overstatements and
understatements.
c.
d.
distribution.
Overstated units have
alowerprobabilityof
sampleselectionthan
units that are
understated.
Theauditorcontrolsthe
riskofincorrectaccep
tancebyspecifyingthat
risklevelforthe
samplingplan.
Thesamplingintervalis
calculatedbydividing
thenumberofphysical
unitsinthepopulation
bythesamplesize.
47. Hillhasdecidedtouse
probabilityproportionaltosize
(PPS)sampling,sometimescalled
dollarunitsampling,intheaudit
ofaclientsaccountsreceivable
balances.Hillplanstousethe
followingPPSsamplingtable:
Number
ofover
statements
0
1
2
3
4
TABLE
ReliabilityFactorsforOverstatements
1%
4.61
6.64
8.41
10.05
11.61
Riskofincorrectacceptance
5%
10%
15%
3.00
2.31
1.90
4.75
3.89
3.38
6.30
5.33
4.72
7.76
6.69
6.02
9.16
8.00
7.27
20%
1.61
3.00
4.28
5.52
6.73
AUDITSAMPLING
a.
b.
c.
d.
Variabilityinthedollar
amountsofinventoryitems
Yes
Yes
No
No
50. Instatisticalsampling
methodsusedinsubstantive
testing,anauditormost
likelywouldstratifya
populationintomeaningful
groupsif
a.Probability
proportionalto
size
(PPS)
samplingisused.
b. The
population
has highly
variable
recorded
amounts.
c.The auditors
estimated
tolerable
misstatement is
extremelysmall.
d. Thestandarddeviation
ofrecordedamountsis
relativelysmall.
Additionalinformation
Tolerablemisstatements
(netofeffectofexpectedmisstatements)
Riskofincorrectacceptance
Numberofmisstatements
Recordedamountofaccountsreceivable
Numberofaccounts
WhatsamplesizeshouldHilluse?
a. 120
b. 108
c. 60
d. 30
48. Inaprobabilityproportionaltosize
samplewithasamplingintervalof
$5,000,anauditordiscoveredthata
selectedaccountreceivablewitha
recordedamountof$10,000hadan
auditamountof$8,000.Ifthiswere
theonlyerrordiscoveredbythe
auditor,theprojectederrorofthis
samplewouldbe
a. $1,000
b. $2,000
c. $4,000
d. $5,000
49. Anauditorisdetermining
thesamplesizeforanin
ventoryobservationusing
meanperunitestimation,
whichisavariables
samplingplan.To
calculatetherequiredsam
51. Theuseoftheratioestimation
sampling technique is most
effectivewhen
a.The calculated audit
amounts
are
approximately
proportional to the
clients
book
amounts.
b.
A relatively small
number
of
differences exist in
thepopulation.
c.Estimating populations
whose records
consistofquantities,
butnotbookvalues.
d. Large overstatement
differences and large
understatement
differences exist in
thepopulation.
52. In the application of statistical
techniques to the estimation of
dollar amounts, a preliminary
sample is usually taken primarily
for the purpose of estimating the
population
a.
b.
c.
d.
Variability.
Mode.
Range.
Median.
plesize,theauditor
usuallydeterminesthe
53.Usingstatisticalsamplingtoassist
inverifyingtheyearendaccounts
payablebalance,anauditorhas
accumulatedthefollowingdata:
Population
Sample
Numberof
accounts
4,100
200
Book
balance
$5,000,000
$250,000
b.
and corresponds
tothesumofall
the individual
bookvalues.
A book value for each
sampleitemisunknown.
c. There are some
observed
differences
between audited
values and book
values.
d. The audited
values are
nearly
proportional to
thebookvalues.
55. Anauditorisperforming
substantivetestsofpricing
andextensionsofperpetual
inventorybalancesconsisting
ofalargenumberofitems.
Pastexperienceindicates
numer
MODULE7AUDITSAMPLING
ouspricing
and
extension
errors.
Whichof
the
following
statistical
sampling
approaches
ismost
appropriate
?
a. Unstratifiedmeanperunit.
b. Probabilityproportionaltosize.
c. Stoporgo.
d. Ratioestimation.
56. The
maj
or
reas
on
that
the
diffe
renc
e
and
ratio
esti
ma
tion
met
hods
wou
ld
be
expe
cted
to
prod
uce
audi
t
effic
ienc
yis
that
the
a.
Num
b
e
r
o
f
m
e
m
b
e
r
219
o
f
t
h
e
p
o
p
u
l
a
t
i
o
n
s
o
f
d
i
f
f
e
r
e
n
c
e
s
o
r
r
a
t
i
o
s
i
s
s
m
a
l
l
e
r
t
h
a
n
t
h
e
b.
n
u
m
b
e
r
o
f
m
e
m
b
e
r
s
o
f
t
h
e
p
o
p
u
l
a
t
i
o
n
o
f
b
o
o
k
v
a
l
u
e
s
.
Betariskmaybecompletelyignored.
c.
Calc
u
l
a
t
i
o
n
s
r
e
q
u
i
r
e
d
i
n
u
s
i
n
g
d
i
f
f
e
r
e
n
c
e
o
r
r
a
t
i
o
e
s
t
i
m
a
t
i
o
n
a
r
e
l
e
s
s
a
r
d
u
o
u
s
a
n
d
d.
Vari
f
e
w
e
r
t
h
a
n
t
h
o
s
e
r
e
q
u
i
r
e
d
w
h
e
n
u
s
i
n
g
d
i
r
e
c
t
e
s
t
i
m
a
t
i
o
n
.
a
b
i
l
i
t
y
o
f
t
h
e
p
o
p
u
l
a
t
i
o
n
s
o
f
d
i
f
f
e
r
e
n
c
e
s
o
r
r
a
t
i
o
s
i
s
l
e
s
s
t
h
a
n
t
h
a
t
o
f
t
h
p
o
p
u
l
a
t
i
o
n
s
o
f
b
o
o
k
v
a
l
u
e
s
o
r
a
u
d
i
t
e
d
v
a
l
u
e
s
.
57. Whic
h of
the
follo
wing
state
ment
s is
corre
ct
conc
ernin
g the
audit
ors
use
of
statis
tical
samp
ling?
a.
An
a
u
d
i
t
o
r
n
e
e
d
s
t
o
e
s
t
i
m
a
t
e
t
h
e
d
o
l
l
a
r
a
m
o
u
n
t
o
f
t
h
e
s
t
a
n
d
a
r
d
d
e
v
b.
An
i
a
t
i
o
n
o
f
t
h
e
p
o
p
u
l
a
t
i
o
n
t
o
u
s
e
c
l
a
s
s
i
c
a
l
v
a
r
i
a
b
l
e
s
s
a
m
p
l
i
n
g
.
a
s
s
u
m
p
t
i
o
n
o
f
P
P
S
s
a
m
p
l
i
n
g
i
s
t
h
a
t
t
h
e
u
n
d
e
r
l
y
i
n
g
a
c
c
o
u
n
t
i
n
g
p
o
p
u
l
a
t
i
o
n
c.
A
i
s
n
o
r
m
a
l
l
y
d
i
s
t
r
i
b
u
t
e
d
.
c
l
a
s
s
i
c
a
l
v
a
r
i
a
b
l
e
s
s
a
m
p
l
e
n
e
e
d
s
t
o
b
e
d
e
s
i
g
n
e
d
w
i
t
h
s
p
e
c
i
a
l
c
o
n
s
i
d
e
r
a
t
i
o
n
s
t
o
i
n
c
l
u
d
e
n
e
g
a
t
i
v
e
b
a
l
a
n
c
e
s
i
n
t
h
e
d.
The
s
a
m
p
l
e
.
s
e
l
e
c
t
i
o
n
o
f
z
e
r
o
b
a
l
a
n
c
e
s
u
s
u
a
l
l
y
d
o
e
s
n
o
t
r
e
q
u
i
r
e
s
p
e
c
i
a
l
s
a
m
p
l
e
d
e
s
i
g
n
c
o
n
s
i
d
e
r
a
t
i
o
n
s
w
h
e
n
u
s
i
n
g
P
P
S
s
a
m
p
l
i
n
g
.
58. Whi
chof
the
follo
wing
most
likel
y
woul
dbe
an
adva
n
tage
in
usin
g
class
ical
varia
bles
sam
pling
rathe
r
than
prob
abilit
y
prop
ortio
nal
to
size
(PPS
)
sam
pling
?
a.
An
e
s
t
i
m
a
t
e
o
f
t
h
e
s
t
a
n
d
a
r
d
d
e
v
i
a
t
i
o
n
b.
The
o
f
t
h
e
p
o
p
u
l
a
t
i
o
n
r
e
c
o
r
d
e
d
a
m
o
u
n
t
s
i
s
n
o
t
r
e
q
u
i
r
e
d
.
a
u
d
i
t
o
r
r
a
r
e
l
y
n
e
e
d
s
t
h
e
a
s
s
i
s
t
a
n
c
e
o
f
c
o
m
p
u
t
e
r
p
r
o
g
r
a
m
t
o
d
e
s
i
g
n
a
n
e
f
f
c.
Incl
i
c
i
e
n
t
s
a
m
p
l
e
.
u
s
i
o
n
o
f
z
e
r
o
a
n
d
n
e
g
a
t
i
v
e
b
a
l
a
n
c
e
s
g
e
n
e
r
a
l
l
y
d
o
d.
Any
e
s
n
o
t
r
e
q
u
i
r
e
s
p
e
c
i
a
l
d
e
s
i
g
n
c
o
n
s
i
d
e
r
a
t
i
o
n
s
.
a
m
o
u
n
t
t
h
a
t
i
s
i
n
d
i
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MODULE7AUDITSAMPLING
220
SIMULATIONS
TaskBasedSimulation1
AnalyzingPPS
Results
Authoritative
Literature
Help
Thefollowingisacomputerprintoutgeneratedbyauditsoftwareusingprobability
proportionaltosize(PPS)sampling:
WinzCorporation
ReceivableSamplingEvaluationResults
December31,20X2
Populationbookvalue=$2,400,000;Tolerablemisstatement=$280,000
ProjectedMisstatement
Bookvalue
$1,000
750
85,000
Auditedvalue
$
0
600
60,000
Tainting
percentage
100%
20%
NA
Misstatement
$1,000
150
25,000
Samplinginterval
$80,000
$80,000
NA
BasicPrecision=3.0*$80,000
IncrementalAllowance
Reliabilityfactor
3.00
4.75
6.30
$240,000
Increment
(Increment1)
1.75
1.55
.75
.55
Projectedmisstatement
$16,000
1,000
ThesoftwareusesfactorsfromthefollowingPPSsamplingtable:
TABLE
ReliabilityFactorsforOverstatements
Numberof
overstatements
0
1
2
3
4
1%
4.61
6.64
8.41
10.05
11.61
Riskofincorrectacceptance
5%
10%
15%
3.00
2.31
1.90
4.75
3.89
3.38
6.30
5.33
4.72
7.76
6.69
6.02
9.16
8.00
7.27
Answerthefollowingquestionsrelatingtotheaboveworksheet:
1.
Questions
Whatwastheplannedsamplesize?
2.
Whatisthetotalmisstatementinthesample?
3.
Projected
misstatement
$1,000
16,000
25,000
$42,000
Whatisthemostlikelytotalmisstatementinthe
population?
4.
Calculatetheupperlimitonmisstatement.
5.
Calculatetheallowanceforsamplingrisk.
6.
Wouldoneacceptorrejectthepopulationasbeing
materiallycorrect?
7.
Whatistheriskofincorrectacceptance?
A.
B.
C.
D.
E.
F.
G.
H.
I.
J.
K.
L.
M.
N.
O.
P.
Q.
R.
S.
Answers
30items
60items
76items
90items
0
$12,550
$26,150
$42,000
$54,550
$80,000
$252,550
$280,000
$294,550
$354,550
Accept
Reject
5%
20%
100%
20%
1.61
3.00
4.28
5.52
6.73
Incrementalallowance
$12,000
__550
$12,550
MODULE7AUDITSAMPLING
TaskBasedSimulation2
PPSSampling
Concepts
Authoritative
Literature
Help
Replyastowhetheryoubelievethefollowingstatementsarecorrector
incorrectconcerningPPSsampling:
1.
2.
3.
4.
5.
6.
I
f
O
7.
8.
P
Tolerablemisstatement
Samplesize
Expectedofmisstatement
Recordedamountofaccountsreceivable
221
9.
Thesamplingintervalis$500.
10. Increasingtheexpectedmisstatementto$10,000willincreasethesamplesize.
TaskBasedSimulation3
Research
Authoritative
Literature
Help
Samplingvs.nonsamplingrisk
AsanewassistantwithWebber&Co.CPAsyouhavebeenaskedtoperform
researchonthenatureofsamplingriskversusnonsamplingrisk.
Selections
A. AU
B. PCAOB
C. AT
D. AR
E. ET
F. BL
G. CS
H. QC
(
A
)
(
B
)
(
C
)
(
D
)
(
E
)
(
F
)
(
G
)
(
H
)
1.
WhichtitleoftheProfessionalStandardsaddressesthisissue?
2.
and
paragraph(s) which
distinguish between
sampling
and
nonsamplingrisk.
222
MODULE7 AUDITSAMPLING
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
d
c
a
d
a
a
d
b
c
a
d
c
__
__
__
__
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__
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__
__
__
__
__
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
d
c
c
b
b
d
c
d
a
d
a
c
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
35.
36.
b
c
a
d
b
a
a
c
b
d
a
b
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
37.
38.
39.
40.
41.
42.
43.
44.
45.
46.
47.
48.
MULTIPLECHOICEANSWER
EXPLANATIONS
requiretheuseofjudgment,al
thoughthatjudgmentisquantified
whenstatisticalsamplingisused.
Answer(c)isincorrectbecause
eitherstatisticalornonstatistical
samplingmayprovideequal
assurancetotheauditor.
A.2.GeneralApproaches
toAuditSampling
Nonstatistical
andStatistical
1.
(d)Therequirementisto
identifyanadvantageof
statisticalsamplingover
nonstatisticalsampling.
Answer(d)iscorrect
becausestatistical
samplinghelpstheauditor
to:(1)designanefficient
sample,(2)measuresthe
sufficiencyofthe
evidentialmatterobtained,
and
(3)evaluatethesampleresults
(AICPAAuditSamplingGuide).
Answer(a)isincorrectbecausedual
purposetests,whichbothtesta
controlandserveassubstantivetest,
maybeperformedwitheithera
statisticaloranonstatisticalsample.
Answer(b)isincorrectbecauseboth
statisticalandnonstatisticalsampling
2.
(c)Therequirementistoidentifyan
advantageofstatisticalsamplingover
nonstatisticalsampling.Answer(c)is
correctbecausestatisticalsampling
helpstheauditorto:
(1)designanefficientsample,(2)
measurethesufficiencyofthe
evidentialmatterobtained,and(3)
evaluatethesampleresults(AICPA
AuditSamplingGuide).Answer(a)is
incorrectbecausetheriskof
nonsamplingerrorsisnotdirectly
affectedbywhetherstatisticalor
nonstatisticalsamplingisused.
Answer(b)isincorrectbecauseeither
statisticalornonstatisticalsampling
canbeusedtoreducethelevelof
auditrisktoalowlevel;the
materialitylevelshouldnotbe
a
d
c
b
b
c
d
c
a
c
d
b
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
49. a
__ __
50. b
__ __
51. a
__ __
52. a
__ __
53. b
__ __
54. b
__ __
55. d
__ __
56. d
__ __
57. a
__ __
58. c
__ __
1st:
__/58=__%
2nd:
__/58=__%
affectedbythetypeofsamplingused.
Answer(d)isincorrectbecause
eitherstatisticalornonstatistical
samplingmaybeusedtominimize
thefailuretodetecterrorsandfraud.
A.3.UncertaintyandAudit
Sampling
3.(a)Therequirementistodetermine
themeaningofthelikelihoodof
assessingcontrolrisktoohighinatest
ofcontrols.Answer(a)iscorrect
becausetheriskofassessingcontrol
risktoohighistheriskthatthesample
doesnotsupporttheauditorsplanned
assessedlevelofcontrolriskwhenthe
trueoperatingeffectivenessofthe
controlstructurejustifiessuchan
assessment.Answer(b)isincorrectbe
causetheriskofassessingcontrolrisk
toohighrelatestothedeviationrate
fromacontrolprocedureina
population,nottomonetary
misstatements.Answer(c)isincorrect
becausetheriskofassessingcontrol
risktoohighdoesnotdirectlyrelateto
monetarymisstatements.Answer(d)is
incorrectbecausetolerableerror
(misstatement)relatestovariables
samplingappliedtosubstantive
testingandnottotestsofcontrols
andbecausethemeaningof
supportthetolerableerroris
uncertain.
4.
(d)Therequirementistodetermine
thenatureoftheriskofincorrect
acceptanceandtheriskofassessing
controlrisktoolow.Answer(d)is
correctbecausetheriskofincorrect
acceptanceandtheriskofassessing
controlrisktoolowrelatetothe
effectivenessofanauditindetecting
anexistingmaterialmisstatementor
deviation.Answer(a)isincorrect
becausethetermallowableriskof
tolerablemisstatementisnotusedin
theprofessionalstandards.Answer
(b)isincorrectbecausepreliminary
estimatesofmaterialitylevelsrelate
mostdirectlytotheriskofincorrect
acceptance,andonlyindirectlytothe
riskofassessingcontrolrisktoolow.
Answer(c)isincorrectbecausethe
riskofincorrectrejectionandthe
riskofassessingcontrolrisktoohigh
relatetotheefficiencyoftheaudit.
5.
(a)Therequirementistodetermine
whichanswerrepresentstheconcept
ofsamplingrisk.Samplingriskarises
fromthepossibilitythatanauditors
conclusionsbaseduponasample
woulddifferfromtheconclusions
whichwouldbedrawnfrom
examiningtheentirepopulation(i.e.,
theriskthatthesampleexaminedis
notrepresentativeofthepopulation).
Answers(b),(c),and(d)areall
incorrectbecausetheyrelatetoerrors
whichcouldoccurevenif100%of
thepopulationwereexamined,thatis,
nonsamplingrisk.
6.
(a)Therequirementisto
determinewhatisrelatedto
theriskofincorrect
rejectionandtheriskof
assessingcontrolrisktoo
high.Answer(a)iscorrect
becauseAU350statesthat
theriskofincorrect
rejectionandtheriskofas
sessingcontrolrisktoohigh
relatetotheefficiencyof
theaudit.Thesetwoerrors
generallyresultinan
auditorperforming
unnecessaryadditional
procedures.Answer(b)is
incorrectbecausetheriskof
incorrectacceptanceandthe
riskofassessingcontrol
risktoolowrelatetothe
effectivenessofanaudit.
Answer(c)isincorrect
becausetherisksdonot
relatedirectlytotheactual
selectionofthesample.
Answer(d)isincorrect
becausetheauditquality
controlsdonotdirectly
mentioneitherofthese
risks.
7.
(d)Therequirementisto
determinethesituationin
whichanauditorhas
properlyconcludedthat
controlriskisatorbelow
theplannedassessedlevel.
Answer(d)iscorrect
becausetosupportthe
plannedlevel,thedeviation
ratemustbelessthanthe
tolerablerateandtheauditor
mustconcludethatthe
deviationrateislessthanthe
tolerable
MODULE7AUDITSAMPLING
rate.Answer(a)isincorrectbecause
itrepresentsasituationinwhichthe
auditorappropriatelydecidesthatthe
deviationrateexceedsthetolerable
rate.Answer(b)isincorrectbecause
itrepresentsasituationinwhichan
auditorerroneouslyconcludesthat
thedeviationrateexceedsthe
tolerableratewhenitactuallydoes
not.Answer(c)isincorrectbecause
theauditorerroneouslyconcludesthat
thedeviationrateislessthanthe
tolerableratewhenitactuallyexceeds
it.
8.
9.
223
isnotmisstated.Answers
(a)and(b)areincorrect
becausetheriskof
assessingcontrolrisktoo
highandtheriskof
assessingcontrolrisktoo
lowrelatetotestsof
controls,andnotto
substantivetestsofdetails.
Answer(d)isincorrect
becausetheriskof
incorrectacceptanceisthe
riskthatthesamplesupport
theconclusionthatthe
accountisnotmisstated
wheninfactitismisstated.
(b)Therequirementisto
A.4.TypesofAuditTestsinWhich
determinethesituationin
SamplingMayBe
whichtheauditorassesses
Used
controlrisktoohighand
therebyincreases
10.(a)Therequirementisto
substantivetesting.Answer
identifythecorrectstatementwith
(b)iscorrectbecauseto
respecttothesizeofasample
assesscontrolrisktoohigh,
requiredfordualpurposetesting.
anauditormustestimate
Answer(a)iscorrectbecausethe
thatthedeviationrate
auditorshouldselectthelargerof
exceedsthetolerablerate
therequiredsamplesizes.
whenitactuallyislessthan
A.5.TypesofStatisticalSampling
thetolerablerate.Answer
(a)isincorrectbecauseit
Plans
representsasituationin
whichtheauditorappropri 11. (d)Therequirementistoidentifythe
typeofsamplinginvolvedina
atelydecidesthatthe
reviewofclientinvoicesinwhichan
deviationrateexceedsthe
expectedpopulationdeviationrate
tolerablerate.Answer(c)is
andanestablishedtolerablerateare
incorrectbecausethe
provided.Answer(d)iscorrect
auditorerroneously
becauseattributesamplingisusedto
concludesthatthedeviation
reachaconclusionaboutapopula
rateislessthanthetoler
tionintermsofarateofoccurrence
ableratewhenitactually
(AuditSamplingGuide).Answer(a)
exceedsthetolerablerate.
isincorrectbecausestratified
Answer(d)isincorrect
samplingisgenerallyusedtoreacha
becausetoproperlyrelyon
dollarbasedconclusioninvariables
internalcontrol,the
samplingapproaches.Answer(b)is
deviationratemustbeless
incorrectbecause,asindicated,
thanthetolerablerateand
variablessamplingdealswithadollar
theauditormustconclude
amountconclusion,notdeviation
thatthedeviationrateisless
rates.Answer(c)isincorrectbecause
thanthetolerablerate.
discoverysamplingisonlyusedin
(c)Therequirementisto
casesinwhichtheauditorexpects
determinethetypeofrisk
deviationratestobeextremelylow
demonstratedwhenan
(approachingzero).
auditorconcludesthatan
12. (c)Therequirementisto
accountismisstatedwhen
identifythesampling
infactitisnot.Answer(c)
methodthatwouldbeused
iscorrectbecausetherisk
toestimateanumerical
ofincorrectrejectionisthe
measurementsuchasa
riskthatthesample
dollarvalueofa
supportstheconclusion
population.Answer(c)
thattherecordedaccount
balanceismaterially
misstatedwhentheaccount
iscorrectbecausesamplingfor
variablesaddressessuchnumerical
measurements.Answer(a)is
incorrectbecauseattributessampling
dealswithdeviationrates.Answer(b)
isincorrectbecausestoporgo
sampling(alsoreferredtoas
sequentialsampling)isaformof
attributessampling.Answer(d)is
incorrectbecauserandomnumber
samplingissimplyasampleselection
techniquethatmaybeusedwith
eitheranattributesoravariables
formofsampling;accordingly,a
numericalmeasurementsuchasa
dollarvalueisnotnecessaryfor
randomnumbersampling.
13.(d)Therequirementisto
determinetheaudittestforwhichan
auditorwouldmostlikelyuse
attributesampling.Answer(d)is
correctbecauseattributesamplingis
usedtoreachaconclusionabouta
populationintermsofarateof
occurrence.Heretherateof
occurrencewillbetherateof
(un)approvedtimecards.Answers
(a),(b),and(c)areallincorrect
becausetheyallrelatemoredirectly
tovariablessamplingwhichis
generallyusedtoreachconclusion
aboutapopulationintermsofa
dollaramount.SeetheAICPAAudit
andAccountingGuide,Audit
SamplingandAU350formore
informationonauditsampling.
GeneralSamplingQuestions
14. (c)Therequirementisto
determinethecorrect
statementwithrespectto
randomsampling.Answer
(c)iscorrectbecauseevery
itemintheaccounting
populationshouldhavean
opportunitytobeselected.
Answer(a)isincorrect
becausewithstratified
randomsampling,each
stratumneednotbegiven
equalrepresentation.
Answer(b)isincorrect
becausewhilesampleunits
shouldberandomly
selected,thereisno
requirementthatthe
accountingpopulationbe
randomlyordered.Answer
(d)isincorrectbecause
randomsampling,byits
verynature,isnot
systematic.Additionally,
randomsamplingmaybe
performedwithoutre
placement.
15. (c)Therequirementisto
determinetheleastdesir
ablestatisticalselection
technique.Answer(c),
blockselection,iscorrect
because,ideally,asample
shouldbeselectedfrom
theentiresetofdatato
whichtheresulting
conclusionsaretobe
applied.Whenblock
samplingisused,the
selectionofblocksoften
precludesitemsfrombeing
soselected.Inmostcases,
systematic[answer(a)],
stratified[answer(b)],and
sequential[answer(d)]
selectiontechniquesall
provideabetter
representationoftheentire
populationthandoesblock
selection.
16. (b)Therequirementistoidentifythe
typeofsamplingplanthatdoesnotuse
afixedsamplesizefortestsofcontrols.
Answer(b)iscorrectbecause
sequentialsamplingresultsinthe
selectionofasampleinseveralsteps,
witheachstepconditionalontheresult
oftheprevioussteps.Therefore,sample
sizewillvarydependinguponthe
numberofstagesthatprovenecessary.
Answers(a),(c),and(d)areall
incorrectbecausedollarunitsampling,
PPSsampling,andvariablessampling
alluseafixedsamplesize.
17. (b)Therequirementisto
identifythecorrectstate
mentconcerningastatistical
samplingapplicationwhere
thepopulationconsistsof
formswhicharenot
consecutivelynumbered.
Answer(b)iscorrectbecause
systematicsamplingisa
procedurewherearandom
startisobtainedandthen
everynthitemisselected.
Forexample,asampleof
fortyfromapopulationofa
thousandwouldrequire
selectingevery25thitem
afterobtainingarandomstart
between
MODULE7AUDITSAMPLING
224
items1through25.Answer(a)is
incorrectbecauseselectionofa
randomsampleispossibleeven
thoughthepopulationisnot
consecutivelynumbered.Answer(c)
isincorrectbecausethereisno
specialreasonforusingstratified
sampling.Stratifiedsamplingbreaks
downthepopulationinto
subpopulationsandappliesdifferent
selectionmethodstoeach
subpopulation.Thisselectionmethod
isusedwhenthepopulationconsists
ofdifferenttypesofitems(e.g.,large
balancesandsmallbalances).
Answer(d)isincorrectbecause
randomnumbertablescanbeused
eventhoughtheformsarenot
consecutivelynumbered.Ifrandom
numbersareselectedforwhichthere
arenoforms,theyareignored.This
isthesameasiftherewere86,000
itemsinaconsecutivelynumbered
populationandrandomnumbers
selectedbetween86,000and99,999
areignored.
subpopulationstoreduce
theeffectofdispersionin
thepopulation.
B.1.TestsofControlsSampling
Risk
20. (d)Therequirementisto
identifythecircumstance
thatwouldcausean
auditortoassesscontrol
risktoolowanddecrease
substantivetesting
inappropriately.Answer
(d)iscorrectbecausewhen
thetruedeviationratein
thepopulationexceedsthat
inthesample,theauditor
mayassesscontrolrisktoo
low.TheAICPAAudit
SamplingGuidediscusses
testsofcontrolsand
attributessamplinginits
secondchapter.Answers
(a)and(c)areincorrectbe
causethetruedeviationrateandthe
riskofassessingcontrolrisktoolow
donothavesucharelationship,either
positiveornegative.Answer(b)is
incorrectbecauseadeviationratein
thepopulationthatislessthanthe
deviationrateintheauditorssample
mayleadtheauditortoassesscontrol
risktoohigh.
18. (d)Answer(d)iscorrectbecause
systematicitemsoccurrenceina
populationmaydestroyasamples
randomness.Answer(a)isincorrect
becauseitemsneednotbereplacedin
thepopulation,andthereforeisnota
disadvantageofsystematicsampling. 21. (a)Therequirementistodetermine
whethertheexpecteddeviationrate,
Answer(b)isincorrectbecausean
thetolerabledeviationrate,orboth
individualitemwillnotoccurmore
affectthesamplesizeforatestof
thanonceinasamplewhen
controls.Answer(a)iscorrect
systematicsamplingisbeingused
becauseattributesamplingformulas
(becausetheauditorselectseverynth
andtablesusedinauditinggenerally
item).Answer(c)isincorrectbe
requiretheauditortospecifyanex
causesystematicsamplingrefersto
pecteddeviationrate,atolerable
thetypeofsamplingselectionplan
deviationrateandtheriskof
usedandnotthemannerinwhich
assessingcontrolrisktoolow.See
itemsinthepopulationarerecorded.
AICPAAuditSamplingGuideand
Also,asindicatedin(d)above,a
AU350formoreinformationonaudit
systematicpatterninthepopulationis
sampling.
ahindrancetosystematicsampling.
19. (c)Stratifiedsamplingisa
techniqueofbreakingthe
populationdowninto
subpopulationsand
applyingdifferentsample
selectionmethodstothe
subpopulations.Stratified
samplingisusedto
minimizethevariance
withintheoverall
population[answer(c)].
Recallthatasvariance
increases,sodoesthe
requiredsamplesize
(becauseoftheextreme
values).Thus,stratification
allowstheselectionof
22. (d)Therequirementisto
identifythecorrectstate
mentaboutsamplingfor
attributes.Answer(d)is
correctbecausethesample
sizeincreasesasthe
tolerableratedecreases,an
inverserelationship.
Answer(a)isincorrect
becausemanydeviationsdo
notnecessarilyresultina
misstatement.Answer(b)
isincorrectbecausea
doublingofthepopulation
sizewillresultinlessthana
doublingoftherequired
samplesize.Answer(c)is
incorrectbecauseauditors
mustconsiderthe
qualitativeaspectsof
deviations.
23. (a)Therequirementistoidentifythe
informationneededinadditiontothe
likelyrateofdeviationsandthe
allowableriskofassessingcontrol
risktoolowtodeterminethesample
sizeforatestofcontrolsinan
attributessamplingplan.Answer(a)
iscorrectbecausethetolerablede
viationrateisalsoneeded.Answer
(b)isincorrectbecausetheriskof
incorrectacceptancerelatesto
variablessamplingappliedto
substantivetesting,notattributes
samplingappliedtotestsofcontrols.
Answer(c)isincorrectbecausethe
auditorwillexaminethenatureand
causeofdeviationsafterthesample
hasbeenselected.Answer(d)is
incorrectbecauseauditorsoftendo
notconsiderpopulationsizewhen
performingattributessampling
appliedtotestsofcontrols.
24. (c)Therequirementisto
determinewhenasample
sizewouldbedecreased
whensamplingfor
attributes.Answer(c)is
correctbecausethesample
sizewilldecreasewhen
theriskofassessing
controlrisktoolowis
increased,thetolerable
rateisincreased,andthe
expectedpopulation
deviationrateisdecreased
(AuditandAccounting
GuideAuditSampling).
Answers(a),(b),and(d)
areallincorrectbecause
theyincludecombinations
ofchangesthatwouldnot
necessarilydecrease
samplesize.
25. (b)Therequirementisto
identifythecorrectstate
mentwithrespectto
treatmentofavoided
voucherthathasbeen
selectedinasample.
Answer(b)iscorrect
becausetheAICPAAudit
SamplingGuidestatesthat
theauditorshouldobtain
reasonableassurancethat
thevoucherhasbeenprop
erlyvoided,andshouldthen
replaceitwithanother
voucher.Answer(a)is
incorrectbecausethe
voidedvoucherisnot
normallyconsideredtobea
deviation.Answer(c)is
incorrectbecausethe
auditormustobtain
reasonableassurancethat
themisplacedvoucherhas
beenvoided.Answer(d)is
incorrectbecausethelevel
ofmaterialitynormallydoes
notdirectlyaffectthe
decision.
26. (c)Therequirementisto
determinetheproper
methodofhandlinga
sampleitemwhichcannot
belocatedforevaluation
purposes.Answer(c)is
correctbecauseanauditor
wouldordinarilyconsider
theselecteditemtobea
deviation.Answers(a)and
(d)areincorrectsincea
possiblecauseforthe
missingpurchaseorder
couldbeabreakdownin
oneofthecontrolsofthe
system.Thus,inselectinga
newsampleitem(s)the
auditormaybeignoringa
portionofthepopulation
whichisinerrorandmay
beartificiallyskewingthe
resultsofthetests
performedonthesample.
Answer(b)isincorrect
becausethereisnoreason
tobelievethattheentiretest
isinvalidandcannotbe
reliedupon.
27. (a)Therequirementisto
determinewhydeviations
fromcontrolproceduresdo
notnecessarilyresultin
errors.Answer(a)is
correctbecauseitprovides
anexampleofasituation
inwhichadeviationfroma
controlprocedureexists
(lackofdocumentationof
transactionapproval),al
thoughtheentrywas
authorizedandproper.
Thus,sucha
MODULE7AUDITSAMPLING
deviationdoesnotnecessarilyresult
inanerrorinthefinancial
statements.Answer(b)isincorrect
becauseadeviationfromcontrol
procedureandanerrormayoccurin
thesametransaction.Answer(c)is
incorrectsincethefactthatall
deviationsdonotleadtoerrorswill
resultinalowererrorrate.Answer
(d)isincorrectbecausewhileit
representsacorrectstatement,itdoes
notfollowfromthepointofthe
questionwhichisbasedontheidea
thatdeviationsdonotdirectlyresult
inerrors.
28. (d)Therequirementisto
determinetheobjectiveof
thetolerableratein
sampling.Tolerablerateis
calculatedtodeterminethe
rangeofprocedural
deviationsinthepopula
tion.Answer(a)isincorrect
becauseprobabilitiesrelate
moredirectlytoreliability.
Answer(b)isincorrect
becauseerrorsonfinancial
statementsinmateriality
termsrelatetovariables
sampling.Answer(c)is
incorrectbecausethe
tolerableratedoesnotrelate
directlytosubstantivetests.
29. (b)Therequirementistodetermine
thecorrectrelationshipbetweenthe
tolerablerateofdeviationsandthe
expectedrateofdeviationsforatest
ofacontrol.Thetolerablerateof
deviationsisthemaximumrateof
deviationsfromaprescribedcontrol
procedurethatanauditorwouldbe
willingtoacceptand,unlessthe
expectederrorrateislower,reliance
oninternalcontrolisnotjustified.
Answer(a)isincorrectbecauseifthe
tolerablerateofdeviationsisless
thantheexpectedrate,theauditor
wouldnotplantorelyoninternal
controlandwouldthereforeomittests
ofcontrols.Answer(c)isincorrect
becausetestingofcontrolsisinap
propriateiftheexpectedrateoferrors
equalsthetolerablerateofdeviations
(mathematically,theprecisionofzero
makesthesamplesizeequalto
populationsize).Answer(d)is
incorrectbecause,asindicatedabove,
toperformtestsofcontrolsonemust
assumethatthetolerablerateof
deviationsismorethantheexpected
errorrate.
30. (a)Therequirementistodetermine
225
thetypeofsamplingwhichismost
directlyrelatedtofindingatleastone
exception.Discoverysamplesizes
andrelateddiscoverysamplingtables
areconstructedtomeasurethe
probabilityofatleastoneerror
occurringinasampleiftheerrorrate
inthepopulationexceedsthe
tolerablerate.Answer(b)isincorrect
becausevariablessamplingneednot
includeatleastoneexception(mean
perunitsampling,forexample,needs
noerrors).Answer(c)isincorrect
sincerandomsamplingonlydeals
withthetechniqueusedtoselect
itemstobeincludedinthesample.
Answer(d)isincorrectbecause
dollarunitsamplingresultsarenot
directlyrelatedtofindingatleastone
exception.
31. (a)Therequirementistodetermine
whetheranauditorshouldconsider
thelikelyrateofdeviation,theal
lowableriskofassessingcontrolrisk
toohigh,orboth,whenperforminga
testofacontrol.Answer(a)iscorrect
becauseanauditorwillconsiderthe
likelyrateofdeviations,butwillnot
ordinarilyconsidertheallowablerisk
ofassessingcontrolrisktoohigh
whenfollowingtheapproachout
linedintheAICPAAuditSampling
Guide.
32. (c)Therequirementistodetermine
whetheranauditorwouldconsiderthe
averagedollarvalueofcheck
requests,theallowableriskof
assessingcontrolrisktoolow,or
both,whentestingwhethercheck
requestshavebeenproperly
authorized.Answer(c)iscorrect
becauseatestofauthorizationsuchas
thisisanattributestestwhichrequires
theauditortodeterminean
allowableriskofassessingcontrol
risktoolow,butdoesnotdeal
directlywithdollarvalues.
Answers(a),(b)and(d)areall
incorrectbecausetheyinclude
incorrectcombinationsofthe
replies.SeeAU350andtheAICPA
AuditSamplingGuidefor
informationonsampling.
B.2.Statistical(Attributes)
SamplingforTestsof
Controls
33. (b)Therequirementistoidentifythe
correctstatementconcerningstatistical
samplingintestsofcontrols.Answer
(b)iscorrectbecausewhiledeviations
frompertinentcontrolprocedures
increasetheriskofmaterialmis
statements,anyspecificdeviationneed
notnecessarilyresultinamisstatement.
Forexample,arecordeddisbursement
thatdoesnotshowevidenceofrequired
approvalmightneverthelessbea
transactionthatisproperlyauthorized
andrecorded(AICPAAuditSampling
Guide).Answer(a)isincorrectbecause
increasesinpopulationsizeresultin
smallincreasesinsamplesize.Answer
(c)isincorrectbecauseadirect
relationship,notaninverserelationship,
existsbetweentheexpectedpopulation
deviationrateandthesamplesizethat
is,increasesintheexpectedpopulation
deviationrateresultinanincreasein
therequiredsamplesize.Answer(d)is
incorrectbecausewhendeterminingthe
tolerablerate,theauditordoesnotyet
havetherequiredsamplesize.
34. (d)Therequirementisto
determinetheproper
evaluationofastatistical
sampleforattributeswhena
testof
50 documentsresultsin3
deviations,givenatolerable
rateof7%,anexpected
populationdeviationrateof
5%,andanallowancefor
samplingriskof2%.Answer
(d)iscorrectbecausewhen
thedeviationrateplusthe
allowanceforsamplingrisk
exceedsthetolerablerate,the
assessedlevelofcontrolrisk
mayincrease.Herethe
deviationrateof6%(3
deviations/50documents)
plustheallowancefor
samplingriskof2%equals
8%andexceedsthetolerable
rateof7%.Answer(a)is
incorrectbecausethe
tolerablerateplusthe
allowanceforsamplingrisk
willalwaysexceedthe
expectedpopulationdeviation
ratewhentestsofcontrolsare
beingperformed.Answer(b)
isincorrectbecausewhenthe
sampledeviationrateplus
theallowanceforsampling
riskexceedsthetolerable
ratethesampleresultsdonot
supporttheplannedassessed
levelofcontrolrisk.Answer
(c)isincorrectbecausethe
tolerableratelessthe
allowanceforsamplingrisk
shouldbecomparedwiththe
actualdeviationrate.
35. (a)Therequirementistodetermine
thecircumstanceinwhichanauditor
woulddecidetoincreasethelevelof
thepreliminaryassessmentofcontrol
risk.Answer(a)iscorrectbecausethe
assessmentofcontrolriskwill
increasewhentheachievedupper
precisionlimit(here8%)exceedsthe
tolerablerate(here7%).Answer(b)
isincorrectbecausetheexpected
deviationratewas21/2%,not7%.
Also,iftheexpecteddeviationrateis
higherthanthepercentageoferrorin
thesample,thepreliminary
assessmentdoesnotneedtobe
increased.Answer(c)isincorrect
becausetheachievedupperprecision
limitwillalwaysexceedthe
percentageoferrorsinthesample.
Answer(d)isincorrectbecause,in
circumstancesinwhichtheauditor
decidestosamplethepopulation,the
expecteddeviationratewillalwaysbe
lessthanthetolerablerate.
36. (b) The requirementis to
determine the allowance
for sampling risk of the
presented sample. When
consider
MODULE7AUDITSAMPLING
226
ingtheallowanceforsamplingrisk,
onemayconsiderboththeplanned
allowanceforsamplingriskorthe
adjustedallowancebasedonthe
sampleresults.Answer(b)iscorrect
becauseboththeplannedand
adjustedallowanceforsamplingrisk
are41/2%(7%2.5%forplanning
purposes,and8%3.5%[7/200]as
adjusted).
37.(a)Therequirementistoidentify
thecorrectstatementconcerning
statisticalsamplingfortestsof
controls.Answer(a)iscorrect
becausepopulationsizehaslittleor
noeffectonsamplesize.Answer(b)
isincorrectbecausethepopulation
deviationratehasasignificanteffect
onsamplesize.Answer(c)is
incorrectbecausesamplesize
increasestoamuchlesserextentthan
doublingasthepopulationsize
doubles.Answer(d)isincorrect
becauseforagiventolerablerate,a
smaller,andnotalarger,samplesize
shouldbeselectedastheexpected
populationdeviationratedecreases.
B.3.NonstatisticalSamplingfor
TestsofControls
38.(d)Therequirementistoidentify
theproperstatementconcerninga
randomsamplewhennonstatistical
attributessamplingisbeingused.
Answer(d)iscorrectbecausethe
deviationrateofthesampleshouldbe
comparedtothetolerabledeviation
rateregardlessofwhetherstatistical
ornonstatisticalsamplingisbeing
used.Answer(a)isincorrectbecause
theriskofassessingcontrolrisktoo
lowshouldbeconsidered,althoughit
maybedonejudgmentally.Answer
(b)isincorrectbecausenonsampling
errorrelatestohumantypeerrors
suchasnotidentifyingadeviation,
andnotspecificallytotheuseof
nonstatisticalsampling.Answer(c)
isincorrectbecausediscovery
samplingwillnotbeusedtoevaluate
theresults.
C.1.TestsofDetailsSampling
Risk
39. (c)Therequirementisto
determinewhethereither
orbothofanincreasein
tolerablemisstatementand
anincreaseinthe
assessedlevelofcontrol
riskincreasesamplesize
inasubstantivetestof
details.Answer(c)is
correctbecausewhilean
increaseintolerable
misstatementdecreases
samplesizefora
substantivetestofdetails,
anincreaseinthe
assessedlevelofcontrol
riskincreasesthesample
sizeforasubstantivetest
ofdetailsbecausealower
levelofdetectionriskis
required.
40. (b)Therequirementisto
determinethepropercourse
ofactionwhenanauditoris
planningasampleofcash
disbursementsandheorshe
isawareofseveralunusu
allylargecash
disbursements.Giventhe
descriptionoftheseveral
disbursementsasunusually
large,anauditorwill
generallytestthem.Answer
(b)isthereforecorrect
becausestratifyingthe
populationwillallowthe
auditortoensureinclusion
ofthedisbursements.The
samplingprocedure
(selectinglessthanall
items)willthenbeapplied
onlytothesmaller
disbursements.Answer(a)
isincorrectbecausethe
existenceofthelarge
disbursementswillhaveno
necessaryrelationshiptothe
tolerablerateofdeviation
whenattributessamplingis
beingused.Answer(c)is
incorrectbecausewhile
increasingthesamplesize
mightbeappropriatein
somevariablessampling
applications(wearenottold
inthisproblemwhether
attributesorvariables
samplingisbeingfollowed),
thefactthatthe
disbursementsaredescribed
asunusuallylargeleads
onetoincludethem.
Answer(d)isincorrect
becauseanauditorwillnot
drawnumeroussamplesto
assureinclusionofthelarge
disbursements.
41. (b)Therequirementisto
determinewhethereither
orbothoftheexpected
amountofmisstatement
andthemeasureof
tolerablemisstatement
influencesamplesizefora
substantivetestofdetails.
Answer(b)iscorrect
becauseboththeexpected
amountofmisstatement
andthetolerable
misstatementaffectsample
size(AICPAAudit
SamplingGuide).Increases
intheexpectedamountof
misstatementsincrease
samplesize,while
increasesinthetolerable
misstatementdecrease
samplesize.
42. (c)Therequirementisto
determinethecorrect
statementconcerningthe
auditorsconsiderationof
tolerablemisstatement.
Answer(c)iscorrectbecause
theconsiderationof
tolerablemisstatementis
relatedtopreliminary
judgmentsinamannersuch
thatwhentheauditors
preliminaryjudgmentsabout
tolerablemisstatementlevels
foraccountsortransaction
typesarecombinedforthe
entireauditplan,the
preliminaryjudgmentsabout
materialitylevelsforthe
financialstatementsarenot
exceeded.Answer(a)is
incorrectbecausethe
auditorsjudgmentof
businessriskrelatedtoa
clientisnotdirectlyrelatedto
tolerablemisstatement.
Answer(b)isincorrect
becausetolerablemis
statementmaybeadjustedfor
qualitativefactors.An
swer(d)isincorrectbecause
tolerablemisstatementmaybe
changedduringtheauditprocess,
especiallyasmisstatementsare
identifiedandtheauditorconsiders
thenatureofthemisstatements.
43. (d)Therequirementisto
determinethefactorthat
wouldleadtolargersample
sizeinasubstantivetestof
details.Answer(d)is
correctbecausethesample
sizerequiredtoachievethe
auditorsobjectiveata
givenriskofincorrect
acceptanceincreasesasthe
auditorsassessmentof
tolerablemisstatementfor
thebalanceorclass
decreases.Answer(a)is
incorrectbecauseagreater
relianceoninternalcontrol
willleadtoasmaller
samplesizeinasubstantive
testofdetails.Answer(b)is
incorrectbecausegreater
relianceuponanalytical
procedureswillresultina
needforlessrelianceon
substantivetestsofdetails
andthereforewillresultina
smallersample.Answer(c)
isincorrectbecausea
smallerexpectedfrequency
oferrorswillgenerally
includeproperly
functioninginternalcontrol
andwillthereforeresultin
asmallersamplefor
substantivetestsofdetails.
44. (c)Therequirementisto
identifythefactorwhich
mustbeknowninorderto
estimatetheappropriate
samplesizewhenusing
variablessampling.Answer
(c)iscorrectbecausethe
auditormustsetan
acceptablelevelofriskfor
bothvariablessamplingand
attributesampling.Answer
(a)isincorrectbecausewhile
theauditorwillconsiderthe
qualitativeaspectsoferrors
whenevaluatingthesample,
theyneednotbeconsidered
indetermininganappropriate
samplesize.Answer(b)is
incorrectbecauseaprimary
objectiveofvariables
samplingistoestimatethe
auditeddollaramountofthe
population.Also,insome
formsofvariablessampling,
knowledgeofbookvaluesis
notnecessary(e.g.,mean
perunit).Answer(d)is
incorrectbecausearateof
errorinthepopulationrelates
toattributesampling.
45. (a)Therequirementistoidentifyan
auditorsmostlikelyresponsetoa
circumstanceinwhichthereisatoler
ablemisstatementof$60,000,andthe
auditorhasdiscoveredmisstatementof
anetoverstatementof$3,500($3,700
$200)when1/20oftheaccounthas
beenincludedinthesample.Because
auditorsmustprojectthemisstatements
totheentirepopulation,onewould
MODULE7AUDITSAMPLING
approximately$70,000(20timesthe
misstatementof$3,500).Sincethis
exceedsthetolerablemisstatement,
thereislittlequestionthattheriskof
materialmisstatementistoohighand
thatthemisstatementinthe
populationexceedsthetolerable
misstatement,thereforeanswer(a)is
correct.Answer(b)isincorrect
becauseitseemsthatthesumof
actualoverstatementand
understatementislikelytoexceedthe
tolerablemisstatement.Also,answer
(b)makeslittlesensesincethere
probablyisnosuchthingasan
unacceptablyhighriskthatthe
tolerablemisstatementexceedsthe
sumofactualoverstatementsand
understatements;insuchacir
cumstancetheauditorsimplyaccepts
thepopulationasbeingmaterially
correct.Answers(c)and(d)are
incorrectbecausethetotalprojected
misstatementmustbecalculatedas
indicatedabove.SeeAU350andthe
AuditSamplingGuideforinformation
onsampling.
C.2.ProbabilityProportionalto
Size(PPS)Sampling
46. (c)Therequirementisto
identifythecorrectstate
mentregardingprobability
proportionaltosize(PPS)
sampling.Answer(c)is
correctbecausewhenusing
PPSsampling,theauditor
controlstheriskofincorrect
acceptancebyspecifyinga
risklevelwhenplanningthe
sample.An
swer(a)isincorrectbecausePPS
samplingdoesnotassumeanormal
distribution.Answer(b)isincorrect
becausethebookvalueoftheunit
determineshowprobableitisthatit
willbeincludedinthesample,not
whetheritisoverorunderstated.
Answer(d)isincorrectbecausethe
samplingintervaliscalculatedby
dividingthebookvalueofthe
populationbythesamplesize.
47. (d)Therequirementisto
determinethesamplesize
thatshouldbeusedina
probabilityproportionalto
size(PPS)sample.One
approachistofirstcalculate
asamplingintervalanduse
ittodeterminean
appropriatesamplesize.
Usingthisapproach,when
providedwiththetolerable
expectamisstatementof
227
misstatementalready
adjustedforexpected
misstatements(asisthe
situationinthisproblem),
onedividesthattotalbythe
numberofexpected
misstatementscolumnfor
theappropriateriskof
incorrectacceptance(the
factthatsomeover
statementsareexpectedis
notused).Herethat
computationis
$24,000/1.61=$14,906.83.
Samplesizeiscomputedby
dividingtherecorded
amountbythesampling
interval,here
$240,000/14,906.83,fora
samplesizeof16.An
alternateapproachistouse
thereliabilityfactorforthe
expectednumberof
overstatements.Inthatcase
thecomputationsbecome
$24,000/3.00=$8,000.
Samplesizeis
$240,000/$8,000=30.In
eithercaseanswer(d)isthe
closestandthereforethe
correctreply.
48. (b)Therequirementisto
determinetheprojected
error(misstatement)ofa
probabilityproportional
tosize(PPS)samplewith
asamplingintervalof
$5,000,whenanauditor
hasdiscoveredthatan
accountwitharecorded
amountof$10,000had
anauditamountof
$8,000.Answer(b)is
correctsince,whenan
accountsrecorded
amountexceedsthe
samplinginterval,the
projectederrorequalsthe
actualmisstatement,here
$2,000($10,000
$8,000).
C.3.ClassicalVariablesSampling
49.(a)Therequirementisto
determinewhetheranauditorusesthe
variabilityindollarvalues,theriskof
incorrectacceptance,orboth,ina
meanperunitestimationvariables
samplingplan.Answer(a)iscorrect
becauseboth
factorsareincludedinasampling
plan.Answers(b),(c)and(d)areall
incorrectbecausetheysuggestthat
oneorbothfactorsarenotconsidered.
SeeAU350andtheAICPAAudit
SamplingGuideforinformationon
sampling.
50. (b)Therequirementisto
identifythecircumstancein
whichanauditormost
likelywouldstratifya
populationintomeaningful
groups.Answer(b)is
correctbecausestratified
samplingisusedto
minimizetheeffecton
samplesizeofvariation
withintheoverall
populationandresultsinthe
largestsavingsfor
populationswithhigh
variability.Answer(a)is
incorrectbecausewhilePPS
samplingmayinessence
stratifyapopulation,the
itemsselected,otherthan
thoselargerthanthe
samplinginterval,arenotin
meaningfulgroups.
Answer(c)isincorrect
becausethetolerable
misstatementinandofitself
willnotleadto
stratification.Answer(d)is
incorrectbecause
stratificationisusedpri
marilywhenthereisa
relativelylargestandard
deviation,notarelatively
smallstandarddeviation.
51. (a)Therequirementisto
determinewhenratioesti
mationsamplingismost
effective.Theratio
estimationsampling
techniqueusestheratio
betweentheauditedtobook
amountsasameasureof
standarddeviationinitssam
plesizecomputation.Answer
(a)iscorrectbecausewhen
auditdifferencesare
approximatelyproportional
toaccountsizethestandard
deviationoftheratioissmall
andthisresultsina
relativelysmallrequired
samplesize.Answer(b)is
incorrectbecausearelatively
largenumberofdifferences
betweenbookandaudited
valuesmustexisttocalculate
areliablestandarddeviation
undertheratiomethod.An
swer(c)isincorrectbecause
whiletheratioestimation
samplingtechniquemaybe
usedwithquantities,itoffers
noparticularadvantageover
othermethods.Answer(b)is
incorrectbecausethe
absolutesizeofdifferences
doesnotmaketheratio
estimationmethodmost
effective.
52. (a)Therequirementisto
determinethepurposeof
takingapreliminarysample
whenoneusesstatisticaltech
niques.Itisnecessaryto
obtainanestimateofa
populationsstandard
deviation(variability)when
calculatingtherequired
samplesizeandwhenusing
samplingtechniques.
Answers(b),(c),and(d)are
incorrectbecause,inmost
statisticaltechniquesusedby
auditors,themode(most
frequentbalance),themedian
(middlebalance)andthe
range(differencebetween
thehighestandlowestvalues)
arenotused.
53. (b)Therequirementisto
determinetheestimated
auditedaccountspayable
balanceusingtheratio
estimationtechnique.
Answer(b)iscorrect
becausetheratioestima
tiontechniqueestimates
theauditedvalueby
multiplyingtheaudited
value/bookvalueofthe
sampletimesthepopu
lationbookvalue.Inthis
case,($300,000/$250,000)
$5,000,000=
$6,000,000.
54. (b)Theratioestimationsampling
techniqueisbasedoncomparingthe
ratioofthebookvaluetotheaudited
valueofthesampleditems.Answer
(b)iscorrectbecausethismethod
cannotbeusedwhenthereisnobook
valuetomakethecomparison.The
circumstancesdescribedinanswers
(a)and(c)arenecessaryforratio
pointandintervalestimation.Answer
(d)describesthecircumstancesin
whichtheuseofratioestimationwill
beefficientintermsofrequired
samplesize.
55. (d) The requirement is to
determine the most appro
priatesamplingapproachfor
substantive tests of pricing
and
228
extensionsofperpetualinventory
balancesconsistingofalarge
numberofitemsforwhichpast
experienceindicatesnumerous
expectedpricingandextension
errors.Answer(d)iscorrect
becauseratioestimationis
appropriate
whentestingapopulationforwhicha
largenumberoferrorsofthisnature
isexpected(AuditandAccounting
Guide,AuditSampling).Answer(a)
isincorrectbecausetheunstratified
meanperunitmethodwilltypically
providealargersamplesizethanthe
ratioestimationmethodtoachievethe
samelevelofsamplingrisk.Thus,the
ratioestimationmethodwouldbe
moreappropriate.Answer(b)is
incorrectbecauseprobability
proportionaltosizesamplingismost
efficientfortestingpopulationswith
relativelylowexpectederrorrates.
Answer(c)isincorrectbecausestop
orgoorsequentialsamplingis
mostfrequentlyusedinattribute
sampling.
56. (d)Differenceandratioestimation
methodsarestatisticalsampling
methods.Theymeasurethedifference
betweenauditandbookvaluesorthe
ratioofaudittobookvalues.Asthese
differencesshouldnotbegreat,the
populationofthesedifferenceswill
havelittlevariance.Instatistical
sampling,thelessvariationina
population,thesmallertherequired
sampletoprovideanestimateofthe
population.Inotherwords,difference
andratioestimationmethodsare
moreefficientbecausethedifferences
betweenauditandbookvaluesare
expectedtovarylessthantheactual
itemsinthepopulation.Answer(a)is
incorrectbecausethenumberof
membersinthepopulationfor
differencesorratiomethodswouldbe
thesameasthenumberofitemsin
thepopulationforadirectestimation
method.Indifferencesampling,many
itemswouldbezerobecauseaudit
andbookarethesame,andinratio
sampling,manyofthemembers
wouldbeoneforthesamereason.
Answer(b)isincorrectbecausebeta
riskcanneverbeignored,asbetarisk
istheriskofacceptinganincorrect
(unacceptable)population.Answer
(c)isincorrectbecausethe
calculationsrequiredindifference
andratiosamplingaresimilarto
thoseusedindirectestimation
sampling.
MODULE7AUDITSAMPLING
57. (a)Therequirementisto
identifythecorrectstate
mentconcerningthe
auditorsuseofstatistical
sampling.Answer(a)is
correctbecauseanestimate
ofthevariationofthe
population,thestandard
deviation,isneededtouse
classicalvariables
sampling(AICPAAudit
andAccountingGuide,
AuditSampling).Answer
(b)isincorrectbecausePPS
samplingdoesnotmakean
assumptionthattheunder
lyingpopulationis
normallydistributed.
Answers(c)
and (d) are incorrect because
classicalvariablessampleselected
accounts and therefore need not
include special considerations to
thosewithanegativebalance.
C.4.ComparisonofPPS
Samplingto
ClassicalVariables
Sampling
58.(c)Therequirementistoidentify
anadvantageinusingclassical
variablessamplingratherthan
probabilityproportionaltosize
sampling.Answer(c)iscorrectbe
causetheinclusionofzeroand
negativebalancesgenerallydoesnot
requirespecialdesignconsiderations
whenusingclassicalsampling,while
itdoeswhenusingprobability
proportionaltosizesampling
(AICPAAuditSamplingGuide).
Answer(a)isincorrectbecause
classicalvariablessamplingdoes
requireanestimateofthestandard
deviationofthepopulations
recordedamounts.Answer(b)is
incorrectbecausethecomputational
processinvolvedwithclassi
calvariablessamplingmaymakeuseof
acomputerprogramdesirable.Answer
(d)isincorrectbecauseprobability
proportionaltosizesampling,not
classicalsampling,automatically
stratifiesindividuallysignificantitems.
MODULE7AUDITSAMPLING
SOLUTIONSTOSIMULATIONS
TaskBasedSimulation1
AnalyzingPPS
Results
Authoritative
Literature
1.
Help
2.
3.
(M)$294,550.Theupperlimitonmisstatementisthesumofprojected
misstatement,basicprecision,andtheincrementalallowance($42,000+
$240,000+$12,550=$294,550).
5.
(K)$252,550.Theallowanceforsamplingriskisthesumofbasic
precision and the incremental allowance ($240,000 + $12,550 =
$252,550).
6.
(Reject)Rejectbecausetheupperlimitonmisstatement($294,550)exceeds
thetolerablemisstatement($280,000).
7.
(5%)Becausebasicprecisionusesa3.0factor,thetestisbeingperformedat
5%.
TaskBasedSimulation2
PPSSampling
Concepts
Correct
5.
Authoritative
Literature
Help
Incorrect
1.
2.
PPSsamplingresultsinastratifiedsample.
3.
Individuallysignificantitemsareautomaticallyidentified.
4.
Ifnomisstatementsareexpected,PPSsamplingwillusuallyresultinasmaller
samplesizethanclassicalvariablessamplingmethods.
6.
OnedoesnotneedabookvalueforindividualitemstoevaluateaPPSsample.
7.
APPSsampleeliminatestheneedtoprojectresultstotheoverallpopulation.
8. PPSsamplingispreferredbytheprofessionalstandards.
9. Thesamplingintervalis$500.*
10. Increasingtheexpectedmisstatementto$10,000willincreasethesamplesize.
*Itistherecordedamountdividedbysamplesize:$300,000/100=$3,000
TaskBasedSimulation3
Research
Authoritative
Literature
Help
229
1.
2.
E
n
MODULE8AUDITINGWITHTECHNOLOGY
230
AUDITINGWITHTECHNOLOGY
MULTIPLECHOICEQUESTIONS(132)
1.
Anadvantageofusingsystems
flowchartstodocument
informationaboutinternalcontrol
insteadofusinginternalcontrol
questionnairesisthatsystems
flowcharts
a.
b.
d.
2.
b.
c.
3.
Identify internal
control weaknesses
moreprominently.
Provide a visual depiction of
clientsactivities.
5.
c. Indicate whether
control procedures
are
operating
effectively.
Reduce the need to observe
clients employees performing
routinetasks.
A flowchart is most
frequentlyusedbyanauditor
inconnectionwiththe
a. Preparation of
generalized
computer audit
programs.
Review of the clients internal
control.
Use of statistical sampling in
performinganaudit.
d. Performance of
analytical
procedures of
accountbalances.
MatthewsCorp.haschangedfroma
systemofrecordingtimeworkedon
clockcardstoacomputerizedpayroll
systeminwhichemployeesrecordtimein
andoutwithmagneticcards.The
computersystemautomaticallyupdatesall
payrollrecords.Becauseofthischange
a. A generalized
computer audit
program must be
used.
b. Partoftheaudittrailisaltered.
c. The potential for
payrollrelated
fraud is dimin
ished.
d. Transactions must be processed
inbatches.
4.
d.
replacedbyonline
realtime
processing in all
but
legacy
systems.
c. It is more likely to
result in an easyto
followaudittrailthan
is online transaction
processing.
It is used only in nondatabase
applications.
Anauditorwouldbemostlikelytoassess
controlriskatthemaximumlevelinan
electronicenvironmentwithautomated
systemgeneratedinformationwhen
a. Sales orders are
initiated using
predetermined,
automated
decisionrules.
b. Payablesarebasedon
manytransactionsand
large in dollar
amount.
c. Fixed
asset
transactions are
fewinnumber,but
large in dollar
amount.
d. Accounts
receivable records
arebasedonmany
transactions and
are large in dollar
amount.
6.
a.
b.
c.
d.
In a highly automated
information processing
systemtestsofcontrol
Must be performed in all
circumstances.
May be required in some
circumstances.
Areneverrequired.
Arerequiredinfirstyearaudits.
7.
a.
b.
c.
8.
Whichofthefollowingisleast
likelytobeconsideredbyan
auditorconsidering
engagementofaninformation
technology(IT)specialistonan
audit?
Complexity of clients systems
andITcontrols.
Requirements to assess going
concernstatus.
Clients use of emerging
technologies.
d. Extent of entitys
participation in
electronic com
merce.
Whichofthefollowing
strategieswouldaCPAmost
likelyconsiderinauditingan
entitythatprocessesmostofits
financialdataonlyinelectronic
form,suchasapaperless
system?
a.
b.
d.
9.
a.
b.
c.
d.
Continuous monitoring
and analysis of
transaction processing
withanembeddedaudit
module.
Verification
of
encrypted digital
certificates used to
monitor
the
authorization of
transactions.
Extensive testing of
firewall boundaries
that restrict the
recording of outside
networktraffic.
Whichofthefollowingisnota
major reason for maintaining
an audit trail for a computer
system?
Deterrenttofraud.
Monitoringpurposes.
Analyticalprocedures.
Queryanswering.
10. Computersystemsaretypically
supportedbyavarietyofutility
software packages that are
importanttoanauditorbecause
they
a.
b.
c.
d.
May
enable
unauthorized
changestodatafiles
if not properly
controlled.
Are very versatile
programs that can
be used on
hardware of many
manufacturers.
May be significant
components of a
clients application
programs.
Are
written
specifically to
enable auditors to
extract and sort
data.
11. Anauditorwouldmostlikely
beconcernedwithwhichofthe
followingcontrolsina
distributeddataprocessing
system?
a. Hardwarecontrols.
b. Systems
documentation
controls.
c. Accesscontrols.
d. Disasterrecoverycontrols.
12. Whichofthefollowingtypes
ofevidencewouldanauditor
mostlikelyexamineto
determinewhetherinternal
controlisoperatingas
designed?
a. Gross margin information
regardingtheclientsindustry.
b. Confirmations of
receivables
verifying account
balances.
c. Client records
documentingtheuse
of
computer
programs.
d. Anticipated results
documentedinbudgets
orforecasts.
13. Anauditoranticipates
assessingcontrolriskatalow
levelinacomputerized
environment.Underthese
circumstances,onwhichof
thefollowingactivitieswould
theauditorinitiallyfocus?
MODULE8AUDITINGWITHTECHNOLOGY
a.
b.
c.
d.
Programmedcontrolactivities.
Applicationcontrolactivities.
Outputcontrolactivities.
Generalcontrolactivities.
14. Afterthepreliminaryphaseof
thereviewofaclients
computercontrols,anauditor
maydecidenottoperform
testsofcontrolsrelatedtothe
controlswithinthecomputer
portionoftheclientsinternal
control.Whichofthe
followingwouldnotbeavalid
reasonforchoosingtoomit
suchtests?
a. The
controls
duplicate operative
controls existing
elsewhere in the
structure.
b. There appear to be
major weaknesses
that would preclude
reliance on the
statedprocedure.
c. The time and dollar costs of
testing exceed the time and
dollar savings in substantive
testing if the tests of controls
show the controls to be
operative.
d. Thecontrolsappearadequate.
15. Auditingbytestingtheinputand
output of a computer system
insteadofthecomputerprogram
itselfwill
a.
Notdetectprogramerrorswhich
do not show up in the output
sampled.
b. Detect all program
errors, regardless of
the nature of the
output.
c. Provide the auditor
withthesametypeof
evidence as tests of
applicationcontrols.
d. Not provide the
auditor
with
confidenceinthere
sults of the auditing
procedures.
16. Whichofthefollowingclient
informationtechnology(IT)
systemsgenerallycanbe
auditedwithoutexaminingor
directlytestingtheITcomputer
programsofthesystem?
a. A system that
performs relatively
uncomplicated
processes and
produces detailed
231
b.
c.
d.
output.
Asystemthataffects
anumberofessential
master files and
produces a limited
output.
Asystemthat
updatesafew
essentialmasterfiles
andproducesno
printedoutputother
thanfinalbalances.
Asystemthatperforms
relatively complicated
processing
and
produces very little
detailedoutput.
17. Anauditorwhowishesto
captureanentitysdataas
transactionsareprocessedand
continuouslytesttheentitys
computerizedinformation
systemmostlikelywoulduse
whichofthefollowing
techniques?
a. Snapshotapplication.
b. Embeddedauditmodule.
c. Integrateddatacheck.
d. Testdatagenerator.
18. Whichofthefollowing
computerassistedauditing
techniquesprocessesclient
inputdataonacontrolledpro
gramundertheauditors
controltotestcontrolsinthe
computersystem?
a. Testdata.
b. Reviewofprogramlogic.
c. Integratedtestfacility.
d. Parallelsimulation.
19. To obtain evidence that
onlineaccesscontrolsare
properly functioning, an
auditormostlikelywould
a. Createcheckpointsat
periodic intervals
after live data
processingtotestfor
unauthorized use of
thesystem.
b.
c.
d.
Examinethe
transactionlogto
discoverwhetherany
transactionswerelost
orenteredtwicedueto
asystemmalfunction.
Enter
invalid
identification numbers
or passwords to
ascertain whether the
systemrejectsthem.
Vouch a random
sample of processed
transactions to assure
properauthorization.
a.
b.
c.
d.
Existence
of
unclaimed payroll
checks held by su
pervisors.
Earlycashingofpayrollchecks
byemployees.
Discovery of invalid employee
I.D.numbers.
Properapprovalofovertimeby
supervisors.
21. Whenanauditortestsacomputerized
accountingsystem,whichofthefollowing
istrueofthetestdataapproach?
a.
Severaltransactionsofeachtype
mustbetested.
b. Test data are
processed by the
clients computer
programsunderthe
auditorscontrol.
c. Testdatamustconsist
of all possible valid
and
invalid
conditions.
d. The program tested
isdifferentfromthe
program
used
throughout the year
bytheclient.
22. Whichofthefollowingisnot
amongtheerrorsthatan
auditormightincludeinthe
testdatawhenauditingacli
entscomputersystem?
a. Numeric characters in
alphanumericfields.
b. Authorizedcode.
c. Differences in description of
unitsofmeasure.
d. Illogical entries in
fieldswhoselogicis
tested
by
programmed
consistencychecks.
23. Whichofthefollowing
computerassistedauditing
techniquesallowsfictitious
andrealtransactionstobepro
cessedtogetherwithoutclient
operatingpersonnelbeing
awareofthetestingprocess?
a. Integratedtestfacility.
b. Inputcontrolsmatrix.
c. Parallelsimulation.
d. Dataentrymonitor.
24. Which of the following
methodsoftestingapplication
controlsutilizesageneralized
audit software package pre
paredbytheauditors?
a. Parallelsimulation.
b. Integrated testing facility
approach.
c. Testdataapproach.
d. Exceptionreporttests.
25. Increatingleadschedulesforan
auditengagement,aCPAoften
usesautomatedworkpaper
software.Whatclient
informationisneededtobegin
thisprocess?
a. Interimfinancial
informationsuchas
thirdquartersales,net
income,and
inventoryand
receivablesbalances.
b. Specializedjournal
informationsuchasthe
invoiceandpurchase
ordernumbersofthe
lastfewsalesand
purchasesoftheyear.
c. General
ledger
information such as
account numbers,
prior year account
balances, and current
year unadjusted
information.
d. Adjusting entry
information such as
deferrals
and
accruals,
and
reclassification
journalentries.
MODULE8AUDITINGWITHTECHNOLOGY
232
26. Usingmicrocomputersinauditing
mayaffectthemethodsusedto
reviewtheworkofstaffassistants
because
a.
b.
c.
d.
analytical
procedures.
c. Substantiate the
accuracy of data
through
self
checking digits and
hashtotals.
d. Reduce the level of
required tests of
controlstoarelatively
smallamount.
29. Auditorsoftenmakeuseof
computerprogramsthatperform
routineprocessingfunctionssuch
assortingandmerging.These
programsaremadeavailableby
electronicdataprocessing
companiesandothersandare
specificallyreferredtoas
a.
b.
c.
d.
Compilerprograms.
Supervisoryprograms.
Utilityprograms.
Userprograms.
30. SmithCorporationhas
numerouscustomers.Acus
tomerfileiskeptondisk
storage.Eachcustomerfile
containsname,address,
creditlimit,andaccount
balance.Theauditorwishes
totestthisfiletodetermine
whethercreditlimitsare
beingexceeded.Thebest
procedurefortheauditorto
followwouldbeto
a. Developtestdatathatwould
causesomeaccountbalances
toexceedthecreditlimitand
determineifthesystem
properlydetectssuch
situations.
b. Develop
a
program
to
compare credit
limits
with
account balances
and print out the
details of any
account with a
balance exceeding
itscreditlimit.
c. Request a printout
of all account
balances so they
can be manually
checkedagainstthe
creditlimits.
d. Requestaprintout
ofasampleof
accountbalancesso
theycanbe
individuallychecked
againstthecredit
limits.
31. An auditor most likely
wouldtestforthepresence
of unauthorized computer
program changes by
runninga
a. Programwithtestdata.
b. Check digit verification
program.
c. Source code comparison
program.
d. Program that computes
controltotals.
32. An entity has the following
invoicesinabatch:
Invoice#
201
202
203
204
a.
b.
c.
d.
Product
F10
G15
H20
K35
Quantity
150
200
250
300
Whichofthefollowingnumbersrepresents
therecordcount?
1
4
810
900
Unitprice
$5.00
$10.00
$25.00
$30.00
MODULE8AUDITINGWITHTECHNOLOGY
SIMULATION
TaskBasedSimulation1
ComputerAudit
TechniquesandTerms
Authoritative
Literature
Help
Computerprocessinghasbecometheprimarymeansusedtoprocessfinancial
accountinginformationinmostbusinesses.Consistentwiththissituation,CPAsmust
haveknowledgeofaudittechniquesusingcomputersandofcomputerterminology.
Selectthetypeofaudittechniquebeingdescribedinitems1through5.Computer
audittechniquesmaybeusedonce,
morethanonce,ornotatall.
A.
B.
C.
D.
1.
2.
D
e
A
D
u
3. F
i
4. M
a
5. U
Computeraudittechnique
Auditingaroundthecomputer
E. Processingoutputcontrol
I/Oauditapproach
F. Testdata
Integratedtestfacility
G. Writeextractroutine
Parallelsimulation
233
Foritems6through10selectthetypeofcomputercontrolthatisdescribedinthe
definitionthatispresented.Eachcontrolmaybeusedonce,morethanonce,ornotatall.
H.
I.
J.
K.
L.
Backupandrecovery
Boundaryprotection
Checkdigit
Controldigit
Fileprotectionring
Control
M.Hashtotal
N. Missingdatacheck
O. Personalidentificationcodes
P. Visitorentrylogs
Description
6. Acontrolthatwilldetectblanksexistingininputdatawhentheyshouldnot.
(H)(I)(J)(K)(L)(M)(N)(O)(P)
7. Acontroltoensurethatjobsrunsimultaneouslyinamultiprogramming
environmentcannotchangetheallocatedmemoryofanotherjob.
8. Adigitaddedtoanidentificationnumbertodetectcertaintypesofdata
transmissionortranspositionerrors.
9. Aterminalcontroltolimitaccesstoprogramsorfilestoauthorizedusers.
10.Atotalofonefieldforalltherecordsofabatchwherethetotalis
meaninglessforfinancialpurposes.
MODULE8AUDITINGWITHTECHNOLOGY
234
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
b
b
b
c
c
b
__
__
__
__
__
__
__
__
__
__
__
__
7.
8.
9.
10.
11.
12.
b
a
c
a
c
c
__
__
__
__
__
__
__
__
__
__
__
__
13.
14.
15.
16.
17.
18.
d
d
a
a
b
d
__
__
__
__
__
__
__
__
__
__
__
__
19.
20.
21.
22.
23.
24.
c
c
b
a
a
a
__
__
__
__
__
__
__
__
__
__
__
__
25.
26.
27.
28.
29.
30.
c
d
c
a
c
b
MULTIPLECHOICEANSWEREXPLANATIONS
becausewhileaflowchart
describesasystem,the
flowchartalonedoesnot
indicatewhetherthatsystemis
operatingeffectively.Answer
(d)isincorrectbecauseauditors
stillneedtodeterminewhether
thesystemhasbeenplacedin
operationandthereforetheneed
toobserveemployees
performingroutinetasksre
mains.
A. Auditors Consideration of
Internal Control When a
ComputerIsPresent
1.
(b)Therequirementisto
identifyanadvantageofusing
systemsflowchartstodocument
informationaboutinternal
controlinsteadofusinginternal
controlquestionnaires.Answer
(b)iscorrectbecause
flowchartsprovideavisual
depictionofclientsactivities
whichmakeitpossiblefor
auditorstoquicklyunderstand
thedesignofthesystem.
Answer(a)isincorrectbecause
whiletheflowofoperationsis
visuallydepicted,internal
controlweaknessesarenotas
obvious.Answer(c)isincorrect
2.
(b)Therequirementisto
determinewhenaflowchartis
mostfrequentlyusedbyan
auditor.Answer(b)iscorrect
becauseflowchartsare
suggestedasbeingappropriate
fordocumentingtheauditors
considerationofinternalcontrol.
Answer(a)isincorrectbecause
__
__
__
__
__
__
__
__
__
__
__
__
31. c
32. b
1st:
2nd:
__
__
__
__
__/32=__%
__/32=__%
auditorsdonotfrequentlywrite
theirowngeneralizedcomputer
auditprograms,themostlikely
timeaflowchartwouldbeused
withrespecttosuchsoftware.
Answers(c)and(d)are
incorrectbecausestatistical
samplingandanalytical
proceduresdonotingeneral
requiretheuseofflowcharts.
3.
4.
(b)Therequirementisto
identifythecorrectstatement
withrespecttoacomputerized,
automaticallyupdatingpayroll
systeminwhichmagneticcards
areusedinsteadofamanual
payrollsystemwithclockcards.
Answer(b)iscorrectbecause
theautomaticupdatingof
payrollrecordsalterstheaudit
trailwhich,inthepast,included
stepspertainingtomanual
updating.Answer(a)is
incorrectbecausealthoughan
auditormaychoosetousea
generalizedcomputeraudit
program,itisnotrequired.
Answer(c)isincorrectbecause
noinformationispresentedthat
wouldnecessarilyindicatea
changeinthelikelihoodof
fraud.Answer(d)isincorrect
becausegivenautomatic
updating,alargeportionofthe
transactionsarenotprocessedin
batches.
(c)Therequirementistoidentifythe
correctstatementconcerningthebatch
processingoftransactions.Batch
processinginvolvesprocessing
transactionsthroughthesystemingroups
ofliketransactions(batches).Answer(c)
iscorrectbecausethesimilarnatureof
transactionsinvolvedwithbatch
processingordinarilymakesitrelatively
easytofollowthetransactionsthroughout
thesystem.Answer(a)isincorrect
becausetransactionsareprocessedby
type,notintheordertheyoccur
regardlessoftype.Answer(b)isincor
rectbecausemanybatchapplicationsstill
existandmightbeexpectedtoexistwell
intothefuture.Answer(d)isincor
rectbecausebatchprocessingmaybe
usedfordatabaseapplications.
5.
(c)Therequirementisto
determinewhenanauditor
wouldbemostlikelytoassess
controlriskatthemaximum
levelinanelectronic
environmentwithautomated
systemgeneratedinformation.
Answer(c)iscorrectbecause
thefewtransactionsinvolvedin
fixedassetsmakeitmostlikely
tobeoneinwhichasubstantive
approachofrestrictingde
tectionriskismostlikelytobe
effectiveandefficient.Answer
(a)isincorrectbecausean
auditormightbeexpectedto
performtestsofcontrolsto
assesscontrolriskbelowthe
maximumwhenautomated
decisionrulesareinvolvedfor
anaccount(sales)which
ordinarilyhasmany
transactions.Answers(b)and
(d)areincorrectbecausethe
numeroustransactionsin
payablesandreceivablesmakeit
likelythatcontrolriskwillbe
assessedbelowthemaximum.
6.
(b)Therequirementisto
identifythemostaccurate
statementwithrespecttotestsof
controlsofahighlyautomated
informationprocessingsystem.
Answer(b)iscorrectbecause
SAS110statesthatinsome
suchcircumstancessubstantive
testsalonewillnotbesufficient
torestrictdetectionrisktoan
acceptablelevel.Answer(a)is
incorrectbecausetestsof
controlsneednotbeperformed
inallsuchcircumstances.
Answer(c)isincorrectbecause
suchtestsaresometimes
required.Answer(d)isincorrect
becausetestsofcontrolsarenot
insuchcircumstancesinallfirst
yearaudits.
7.
(b)Therequirementisto
identifytheleastlikely
circumstanceinwhichan
auditorwouldconsiderengage
mentsofanITspecialistonan
audit.Answer(b)iscorrect
becausetherequirementto
assessgoingconcernstatusre
mainsthesameonallaudits,
andthusdoesnotdirectlyaf
fectengagementofanIT
specialist.Answers(a),(c),and
(d)areallincorrectbecausecomplexity,
theuseofemergingtechnologies,and
participationinelectroniccommerceare
allfactorswhichSAS110suggestsmake
itmorelikelythatanITspecialistwillbe
engaged.
8.
(a)Therequirementistoidentifyastrategy
thataCPAmostlikelywouldconsiderin
auditinganentitythatprocessesmostofits
financialdataonlyinelectronicform.
Answer(a)iscorrectbecausecontinuous
monitoringandanalysisoftransaction
processingwithanembeddedauditmodule
mightprovideaneffectivewayofauditing
theseprocessesalthoughsomequestion
existsastohowmanyembeddedaudit
modulesCPAshaveactuallyusedinprac
tice.Answer(b)isincorrectbecausethere
maywellbeadecreaseinrelianceon
internalcontrolactivitiesthatemphasize
thissegregationofdutiessincesomany
controlsareinthehardwareandsoftwareof
theapplication.Answer(c)isincorrect
becausedigitalcertificatesdealwith
electroniccommercebetweencompanies,a
topicnotdirectlyaddressedbythis
question,andbecausesuchcertificatespro
MODULE8AUDITINGWITHTECHNOLOGY
videlimitedevidenceonauthorization.
Answer(d)isincorrectbecausewhile
firewallsdocontrolnetworktraffic,this
isnotthemostsignificantfactorinthe
auditofelectronicformfinancialdata.
9.
(c)Therequirementistoidentifythereply
thatisnotamajorreasonformaintaining
anaudittrailforacomputersystem.
Answer(c)iscorrectbecauseanalytical
proceduresusetheoutputsofthesystem,
andthereforetheaudittrailisoflimited
importance.Answer(a)isincorrectbe
causeanaudittrailmaydeterfraudsince
theperpetratormayrealizethathisorher
actmaybedetected.Answer(b)is
incorrectbecauseanaudittrailwillhelp
managementtomonitorthecomputer
system.Answer(d)isincorrectbecause
anaudittrailwillmakeitmucheasierto
answerqueries.
10. (a)Therequirementisto
identifyareasonthatutility
softwarepackagesare
importanttoanauditor.An
swer(a)iscorrectbecause
clientuseofsuchpackagesre
quiresthattheauditorinclude
teststodeterminethatno
unplannedinterventionsusing
utilityroutineshavetakenplace
duringprocessing(Auditand
AccountingGuide,
ComputerAssistedAuditTechniques).
Answer(b)isincorrectbecauseaclients
useofsuchprogramsimpliesthatthey
areusefulonhis/hercomputerhardware,
andthereforeanyflexibilityisnotof
immediaterelevancetotheauditor.
Answer(c)isincorrectbecausethe
primarypurposeofutilityprogramsisto
supportthecomputerusersapplications
(ComputerAssistedAuditTechniques).
Answer(d)isincorrectbecauseutility
softwareprogramshaveavarietyofuses
inadditiontoenablingauditorstoextract
andsortdata(ComputerAssistedAudit
Techniques).
11. (c)Therequirementistoidentifythe
typesofcontrolswithwhichanauditor
wouldbemostlikelytobeconcernedina
distributeddataprocessingsystem.A
distributeddataprocessingsystemisone
inwhichthereisanetworkofremote
computersites,eachhavingacomputer
connectedtothemaincomputersystem,
thusallowingaccesstothecomputersby
variouslevelsofusers.Accordingly,
answer(c)iscorrectbecausenumerous
individualsmayaccessthesystem,
therebymakingsuchcontrolsofextreme
importance.Answers(a),(b),and(d),
235
whilerequiringconcern,arenormally
consideredlesscriticalthanproperaccess
controlsforthissituation.
12. (c)Therequirementisto
identifythetypeofevidencean
auditorwouldexamineto
determinewhetherinternal
controlisoperatingasdesigned.
Answer(c)iscorrectbecause
theinspectionofdocumentsand
recordssuchasthoserelatedto
computerprogramsrepresents
anapproachforobtainingan
understandingofinternal
control.Answer(a)isincorrect
becauseexamininggross
margininformationismore
likelytobeperformedduring
theperformanceofanalytical
procedures.Answer(b)is
incorrectbecauseconfirmingof
receivablesisasubstantivetest.
Answer(d)isincorrectbecause
anticipatedresultsdocumented
inbudgetsorforecastsaremuch
morefrequentlyusedinthe
performanceofanalytical
procedures.
13. (d)Therequirementisto
determinetheprocedureson
whichtheauditorwould
initiallyfocuswhenanticipating
assessingcontrolriskatalow
level.Answer(d)iscorrect
becauseauditorsusuallybegin
byconsideringgeneralcontrol
procedures.Sincethe
effectivenessofspecific
applica
bedifferentthantheevidence
obtainedbytestingtheprogram
tioncontrolsisoftendependentonthe
itself.Answer(d)isincorrect
existenceofeffectivegeneralcontrols
overallcomputeractivities,thisisusually
becausesuchauditingofinputs
anefficientapproach.Answers(a),(b),
andoutputsmaywellsatisfythe
and(c)areallincorrectbecausethey
auditor.
representcontrolsthatareusuallytested
16. (a)Therequirementistoidentifythetype
subsequenttothegeneralcontrols.
ofcomputersystemthatcanbeaudited
14. (d)Therequirementisto
withoutexaminingordirectlytesting
determineaninappropriate
computerprograms(i.e.,auditingaround
reasonforomittingtestsof
thesystem).Auditingaroundthesystem
ispossibleifthesystemperforms
controlsrelatedto
uncomplicatedprocessesandproduces
computercontrolprocedures.
detailedoutput(i.e.,isafancy
Answer(d)iscorrectbecause
bookkeepingmachine).Answers(b),(c),
thefactthatthecontrolsappear
and(d)alldescribemorecomplicated
adequateisnotsufficient
computersystemsthatproduceonly
justificationforreliance;tests
limitedoutput.Inthesemorecomplicated
ofcontrolsmustbeperformed
systems,thedataandrelatedcontrolsare
beforetheauditorcanactually
withinthesystem,andthustheauditor
relyuponacontrolprocedureto
mustexaminethesystemitself.Auditors
reducecontrolrisk.Answer(a)
mustidentifyandevaluatetheac
isincorrectbecausewhen
countingcontrolsinallcomputersystems.
controlsduplicateothercontrols
Further,complexcomputersystems
theauditorwhowishestorely
requireauditorspecializedexpertiseto
uponinternalcontrolneednot
performthenecessaryprocedures.
testbothsets.An
swer(b)isincorrectbecauseifweak
controlsarenottobereliedupon,the
auditorneednottesttheireffectiveness.
Answer(c)isincorrectbecausetestsof
controlsmaybeomittediftheircost
exceedsthesavingsfromreducedsub
stantivetestingresultingfromreliance
uponthecontrols.
15. (a)Therequirementisto
determinethecorrectstatement
withrespecttotestinginputs
andoutputsofacomputer
systeminsteadoftestingthe
actualcomputerprogramitself.
Answer(a)iscorrectbecause
portionsoftheprogramwhich
haveerrorsnotreflectedonthe
outputwillbemissed.Thus,ifa
loopinaprogramisnotused
inoneapplication,itisnot
tested.Answer(b)isincorrect
becausethelackofan
understandingoftheentire
programprecludesthedetection
ofallerrors.Answer(c)is
incorrectbecausewhileauditing
inputsandoutputscanprovide
valuableevidence,itwilloften
17. (b)Therequirementisto
determineanaudittechniqueto
determinewhetheranentitys
transactionsareprocessedandto
continuouslytestthe
computerizedinformation
system.Answer(b)iscorrect
becauseanembeddedaudit
moduleisinsertedwithinthe
clientsinformationsystemto
continuouslytesttheprocessingof
transactions.Answer(a)is
incorrectbecauseasnapshot
applicationanalyzesthe
informationsystematonepointin
time.Answer(c)isincorrect
becauseanintegrateddatacheck
simplytestsdataatonepointin
time.Answer(d)isincorrect
becauseatestdatagenerator
providesasampleofpossible
circumstancesinwhichdatamight
beimproperlyprocessed.
18. (d)Therequirementistoidentify
thecomputerassistedaudit
techniquethatprocessesclient
inputdataona
236
MODULE8AUDITINGWITHTECHNOLOGY
controlledprogramundertheauditors
controltotestcontrolsinacomputer
systemAnswer(d)iscorrectbecause
parallelsimulationprocessesactualclient
datathroughanauditorsgeneralized
auditsoftwareprogram.Answer(a)is
incorrectbecausetestdataisasetof
dummytransactionsdevelopedbythe
auditorandprocessedbytheclientspro
gramstodeterminewhetherthecontrols
whichtheauditorintendstotestare
operatingeffectively.Answer(b)isincor
rectbecauseareviewofprogramlogicis
anapproachinwhichanauditorreviews
thestepsbywhichtheclientsprogram
processesdata.Answer(c)isincorrect
becauseanintegratedtestfacility
introducesdummytransactionsintoa
clientssysteminthemidstoflive
transactions.
B.ComputerizedAuditTools
19. (c)Therequirementistodeterminethe
bestwaytoobtainevidencethatonline
accesscontrolsareproperlyfunctioning.
Answer(c)iscorrectbecauseentering
invalididentificationnumbersor
passwordswillprovidetheauditorwith
evidenceonwhethercontrolsare
operatingasdesigned.Answer(a)is
incorrectbecausedirectlytestingaccess
controlsismoredirectthantestingdata
throughcheckpointsatintervals.Answer
(b)isincorrectbecauseatransactionlog
willnotingeneral,byitself,identify
whethertransactionswerelostorentered
twice.Answer(d)isincorrectbecause
vouchingproperauthorizationisonlyone
measureofwhethercontrolsareproperly
functioning.
20. (c)Therequirementistoidentifythe
situationinwhichitismostlikelythatan
auditorwouldintroducetestdataintoa
computerizedpayrollsystem.Testdatais
asetofdummytransactionsdevelopedby
theauditorandprocessedbytheclients
computerprograms.Thesedummy
transactionsareusedtodetermine
whetherthecontrolswhichtheauditor
testsareoperatingeffectively.Answer(c)
iscorrectbecausetestdatawithinvalid
employeeI.D.numberscouldbe
processedtotestwhethertheprogram
detectsthem.Answer(a)isincorrect
becausetheunclaimedpayrollchecksare
heldbythesupervisorsandnotestingof
thecomputerprogramisinvolved.
Answer(b)isincorrectbecauseno
computerprocessingisgenerallyinvolved
whenpayrollchecksarecashedearlyby
employees.Answer(d)isincorrect
becausetotestwhethertheapprovalof
overtimeisproper,onemustdetermine
whatcriteriaareusedforthedecisionand
mustthendeterminewhethersupervisors
arefollowingthosecriteria;itisless
likelythatthiswillallbeincludedina
computerprogramthanatestforinvalid
employeeIDnumbers.
21. (b)Therequirementisto
identifythecorrectstatement
regardingthetestdataapproach.
Answer(b)iscorrectbecause
thetestdataapproachconsists
ofprocessingasetofdummy
transactionsontheclients
computersystem.Thetestdata
approachisusedtotestthe
operatingeffectivenessof
controlstheauditorintendsto
relyupontoassesscontrolrisk
atalevellowerthanthe
maximum.Answer(a)isin
correctbecauseonlyone
transactionofeachtypeis
generallytested.Answer(c)is
incorrectbecauseitisnot
possible
toincludeallpossiblevalidandinvalid
conditions.Answer(d)isincorrect
becausetheprogramthatshouldbe
testedistheclientsprogramwhichis
usedthroughouttheyear.
22.(a)Therequirementistodetermine
whichreplyisnotamongtheerrors
whicharegenerallydetectedbytest
data.Anauditorusestestdatato
determinewhetherpurportedcontrols
areactuallyfunctioning.Answer(a)is
correctbecauseonewouldnotusetest
datatotestnumericcharactersin
alphanumericfields;numericcharacters
areacceptedinalphanumericfieldsand
thusdonotrepresenterrorconditions.
Answer(b)isincorrectbecause
authorizationcodesmaybetestedby
inputtinginappropriatecodes.Answer(c)
isincorrectbecausedifferingdescriptions
ofunitsofmeasuremaybeinputtedto
testwhethertheyareaccepted.Answer
(d)isincorrectbecauseillogicalcombi
nationsmaybeinputtedtotestwhether
theyaredetectedbythesystem.
23. (a)Therequirementisto
identifythecomputerassisted
auditingtechniquewhichallows
fictitiousandrealtransactionsto
beprocessedtogetherwithout
clientoperatingpersonnelbeing
awareofthetestingprocess.An
swer(a)iscorrectbecausethe
integratedtestfacilityapproach
introducesdummytransactions
intoasysteminthemidstoflive
transactions.Accordingly,client
operatingpersonnelmaynotbe
awareofthetestingprocess.An
swer(b)isincorrectbecausean
inputcontrolmatrixwould
simplyindicatevariouscontrols
intheformofamatrix.
Answer(c)isincorrectbecausethe
parallelsimulationtechniquerequiresthe
processingofactualclientdatathroughan
auditorssoftwareprogram.Inthiscase,
theclientwouldbeawareofthetesting
processsincetheauditorwouldneedto
requestcopiesofdatarunontheactual
systemsothatthedatacouldthenberun
ontheauditorssoftwareprogram.
Additionally,onlyvalidtransactions
wouldbetestedunderparallelsimulation.
Answer(d)isincorrectbecausetheclient
wouldgenerallybeawareofanauditor
usingadataentrymonitor(screen)to
inputtransactions.
24. (a)Therequirementisto
determinetheauditingtechnique
whichutilizesgeneralizedaudit
software.Answer(a)iscorrect
becausetheparallelsimulation
methodprocessestheclients
datausingtheCPAssoftware.
Answers(b)and(c)are
incorrectbecausetheclients
hardwareandsoftwareare
testedusingtestdatadesigned
bytheCPA.Answer(d)is
incorrectbecausealthougha
CPAmaytestaclients
exceptionreportsinvarious
manners,generalizedsoftwareis
unlikelytobeused.Exception
reportsaregenerallytestedvia
CPApreparedtestdata
containingallthepossibleerror
conditions.Thetestdataare
thenrunontheclients
hardwareandsoftwareto
ascertainwhethertheexception
reportsarepickingupthe
CPAstestdata.
25. (c)Therequirementisto
identifytheinformationthat
mustbeavailabletobegin
creatingautomatedlead
schedules.Aleadscheduleis
usedtosummarizelikeac
counts(e.g.,ifaclienthasfive
cashaccountsthoseaccounts
maybesummarizedonalead
schedule).Answer(c)iscor
rectbecauseleadschedules
includeinformationsuchas
accountnumbers,prioryear
accountbalances,andcurrent
yearunadjustedinformation.
Answer(a)isincorrectbecause
interiminformationisnot
necessary.Answer(b)is
incorrectbecauseinvoiceand
purchaseordernumbersarenot
summarizedonleadschedules.
Answer(d)isincorrectbecause
adjustingentryinformationis
identifiedsubsequenttothe
creationofleadschedules.
26. (d)Therequirementistoidentify
aneffectonauditworkreview
methodsofusingmicrocomputers
inauditing.Answer(d)iscorrect
becausemicrocomputerstypically
produceanumberofthe
workingpapersincomputer
disk
MODULE8AUDITINGWITHTECHNOLOGY
formandbecausemanycomputations,etc.
willbeperformeddirectlybythe
computerwithfewdetailsofthecal
culationsconvenientlyavailable.Answer
(a)isincorrectbecausethefieldwork
standardsremainthesameregardlessof
whetherornotcomputersarebeing
utilized.Answer(b)isincorrectbecause
onewouldnotnormallyexpectconsulting
servicespersonneltohelpwith
documentation.Answer(c)isincorrect
becausesupervisorypersonnelmusthave
anunderstandingofthecapabilityand
limitationsofmicrocomputersbeforethey
areutilizedonaudits.
27. (c)Therequirementisto
determineanauditorsleast
likelyuseofcomputersoftware.
Answer(c)iscorrectbecausean
auditorwilljudgmentallyassess
controlriskrelatedtoboththe
computerandmanualsystems
afterhavingperformedthe
varioustestsofcontrols.
Answer(a)isincorrectbecause
computersoftwarewillbeused
toaccessclientdatafiles.
Answers(b)and(d)are
incorrectbecausesoftwareis
usedtopreparespreadsheets
andtoperformparallel
simulations.
28. (a)Therequirementisto
identifyaprimaryadvantage
ofusinggeneralizedaudit
softwarepackagestoauditthe
financialstatementsofaclient
thatusesacomputersystem.
Answer(a)iscorrectbecause
generalizedauditsoftware
allowsanauditortoperform
auditstestsonaclients
computerfiles.Answer(b)is
incorrectbecausegeneralized
auditsoftwarepackagesmay
assisttheauditorwitheither
substantivetestsoftransactions
oranalyticalprocedures.
Answer(c)isincorrectbecause
whilegeneralizedaudit
softwaremightbeusedto
performsuchoperations,thisis
nottheirprimaryadvantage.
Answer(d)isincorrectbe
causegeneralizedaudit
softwarepackageshaveno
directrelationshiptothe
performanceoftestsof
controls.
29. (c)Therequirementistodeterminethe
typeofcomputerprogramswhich
auditorsusetoassisttheminfunctions
237
suchassortingandmerging.Answer(c)
iscorrectbecauseautilityprogramisa
standardroutineforperforming
commonlyrequiredprocessingsuchas
sorting,merging,editing,and
mathematicalroutines.Answer(a)is
incorrectbecausecompilerprograms
translateprogramminglanguagessuchas
COBOLorFORTRANtomachine
language.Answer(b)isincorrectbecause
supervisoryprogramsoroperating
systemsconsistofaseriesofprograms
thatperformfunctionssuchasscheduling
andsupervisingtheapplicationprograms,
allocatingstorage,controllingperipheral
devices,andhandlingerrorsandrestarts.
Answer(d)isincorrectbecauseuseror
applicationprogramsperformspecific
dataprocessingtaskssuchasgeneral
ledger,accountspayable,accounts
receivable,andpayroll.Application
programsmakeuseofutilityroutines.
30. (b)Therequirementisto
determinethebestapproach
fordeterminingwhethercredit
limitsarebeingexceeded
whenaccountsreceivable
informationisstoredondisk.
Answer(b)iscorrectbecause
aprogramtocompareactual
accountbalanceswiththe
predeterminedcreditlimitand
therebyprepareareporton
whetheranyactualcredit
limitsarebeingexceededwill
accomplishthestatedobjec
tive.Answer(a)isincorrect
becausewhiletestdatawill
indicatewhethertheclientsprogram
allowscreditlimitstobeexceeded,it
willnotindicatewhethercreditlimits
areactuallybeingexceeded.Answer(c)
isincorrectbecauseamanualcheckofall
accountbalanceswillbeverytimecon
suming.Answer(d)isincorrectbecause
asamplewillpro
videlesscompleteinformationthan
theauditoftheentirepopulation
whichisindicatedinanswer(b).
detectingunauthorizedchangesthanwill
sourcecodecomparison.Answer(b)is
incorrectbecausecheckdigitsare
primarilyusedasaninputcontrolto
determinethatinputdataisproper.
Answer(d)isincorrectbecauseproperly
computingcontroltotalsisonlyone
possibleunauthorizedchangethatmight
bemadetoaprogram.
31. (c)Therequirementistoidentifyhowan
auditorwouldtestforthepresenceof
unauthorizedcomputerprogramchanges.
Answer(c)iscorrectbecausecomparing
sourcecodeoftheprogramwithacorrect
32. (b)Therequirementistoidentifythe
versionoftheprogramwilldisclose
unauthorizedcomputerprogramchanges.
numberthatrepresentstherecordcount.
Answer(a)isincorrectbecausetestdata
Answer(b)iscorrectbecausetherecord
isgenerallyusedtotestspecificcontrols
countrepresentsthenumberofrecordsin
anditwillgenerallybelesseffectivefor
afile,inthiscase4.
MODULE8AUDITINGWITHTECHNOLOGY
238
SOLUTIONTOSIMULATION
TaskBasedSimulation1
ComputerAudit
1.
2.
3.
4.
5.
D
e
A
D
u
F
i
M
a
U
E
TechniquesandTerms
Authoritative
Literature
Help
4.
1.
(A)Auditingaroundthecomputerinvolvesexamininginputsintoand
outputsfromthecomputerwhileignoringprocessing,ascontrastedto
auditingthroughthecomputerwhichinsomemannerdirectlyutilizesthe
computersprocessingability.
2.
(F) Test data is a set of dummy transactions developed by the auditor and
processedbytheclientscomputerprogramstodeterminewhetherthecontrols
thattheauditorintendstorelyuponarefunctioningasexpected.
3.
(C)Anintegratedtestfacilityintroducesdummytransactionsintoasystemin
themidstoflivetransactionsandisoftenbuiltintothesystemduringthe
originaldesign.
(C)Anintegratedtestfacilityapproachmayincorporateasimulateddivisionorsubsidiary
intotheaccountingsystemwiththesolepurposeofrunningtestdatathroughit.
5.
6.
7.
8.
9.
D
e
A
A
10. A
8.
6.
(N)Amissingdatachecktestswhetherblanksexistininputdatawherethey
shouldnot(e.g.,anemployeesdivisionnumber).Whenthedataismissing,an
errormessageisoutput.
7.
(I)Boundaryprotectionisnecessarybecausemostlargecomputershavemore
than one job running simultaneously (a multiprogramming environment). To
ensure that these simultaneous jobs cannot destroy or change the allocated
memory of another job, the systems software contains boundary protection
controls.
(J)Acheckdigitisanextradigitaddedtoanidentificationnumbertodetectcertaintypes
ofdatatransmissionortranspositionerrors.Itisusedtoverifythatthenumberwasentered
intothecomputersystemcorrectly;oneapproachisusingacheckdigitthatiscalculatedas
amathematicalcombinationoftheotherdigits.
9.
(O)Personalidentificationcodesrequireindividualstoinsomemanneridentify
themselvestodeterminethatonlyauthorizedusersaccessprogramsorfiles.
10. (M)Ahashtotalisthetotalofonefieldforalltherecordsofabatchwherethe
totalisameaninglesstotalforfinancialpurposes,suchasamathematicalsumof
employeesocialsecuritynumberstodeterminethatallemployeeshavebeen
processed.
FINANCIALACCOUNTING
ANDREPORTING
TheFinancialAccountingandReportingExamisscheduledforfourhours.Basedoninformationreleasedbythe
AICPA,candidatesshouldexpectthreemultiplechoicetestletsofapproximatelythirtyquestionseach,andtwo
simulations.
TheUniformCPAExaminationContentSpecificationsappearinVolume1,OutlinesandStudyGuides.
Module9/BasicTheoryandFinancialReporting(TREP)
A.BasicConcepts
83 MultipleChoice
3 TaskBasedSimulations
241
249
254
263
B.ErrorCorrection
15 MultipleChoice
6 TaskBasedSimulations
268
270
274
276
C.AccountingChanges
29 MultipleChoice
7 TaskBasedSimulations
280
283
288
290
D.FinancialStatements
114 MultipleChoice
13 TaskBasedSimulations
295
306
315
324
333
340
346
354
361
372
377
386
Module10/Inventory(INVY)
68MultipleChoice
11TaskBasedSimulations
Module11/FixedAssets(FA)
102 MultipleChoice
11 TaskBasedSimulations
Module12/MonetaryCurrentAssetsandCurrentLiabilities(CACL)
116MultipleChoice
9TaskBasedSimulations
392
405
309
421
Module13/PresentValue(PV)
A.Fundamentals
25 MultipleChoice
5 TaskBasedSimulations
426
429
432
435
B.Bonds
43 MultipleChoice
7 TaskBasedSimulations
437
442
446
451
C.DebtRestructure
8 MultipleChoice
2 TaskBasedSimulation
456
457
458
459
D.Pensions
43 MultipleChoice
3 TaskBasedSimulation
460
465
467
471
E.Leases
60 MultipleChoice
9 TaskBasedSimulations
473
480
484
490
239
240
CH3FINANCIALACCOUNTINGANDREPORTING
Module14/DeferredTaxes(DETX)
44 MultipleChoice
8 TaskBasedSimulations
494
499
503
509
513
523
529
540
546
553
559
567
573
577
582
588
592
601
605
613
Module15/StockholdersEquity(STK)
94 MultipleChoice
10 TaskBasedSimulations
Module16/Investments(IVES)
64 MultipleChoice
11 TaskBasedSimulations
Module17/StatementofCashFlows(SCF)
39 MultipleChoice
6 TaskBasedSimulations
Module18/BusinessCombinationsandConsolidations(BCC)
79 MultipleChoice
8 TaskBasedSimulations
Module19/DerivativeInstrumentsandHedgingActivities(DIHA)
51 MultipleChoice
7 TaskBasedSimulations
617
622
626
630
A.PersonalFinancialStatements
17 MultipleChoice
634
636
B.InterimReporting
19 MultipleChoice
638
640
C.SegmentReporting
12 MultipleChoice
5 TaskBasedSimulations
642
644
646
647
D.PartnershipAccounting
23 MultipleChoice
6 TaskBasedSimulations
649
652
655
658
E.ForeignCurrencyTranslation
13 MultipleChoice
3 TaskBasedSimulations
661
663
666
668
670
682
695
704
Module20/Miscellaneous(MISC)
Module21/Governmental(StateandLocal)Accounting
124MultipleChoice
Module22/NotforProfitAccounting(NFP)
83 MultipleChoice
FinancialAccountingandReportingSampleExamination
1233
FinancialAccountingandReportingAICPASampleTestlets
1306
FinancialAccountingandReporting2011ReleasedAICPAQuestions
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
241
1344
BASICCONCEPTS
MULTIPLECHOICEQUESTIONS(183)
1.
AccountingConceptsintendedtoestablish?
a. Generally accepted accounting
principles in financial reporting by
b.
c.
d.
2.
a.
b.
c.
d.
3.
Theobjectivesandconceptsforusein
developing standards of financial
accountingandreporting.
Thehierarchyofsourcesofgenerally
acceptedaccountingprinciples.
AccordingtotheFASBconceptualframework,
theobjectivesoffinancialreportingforbusiness
enterprisesarebasedon
Generallyacceptedaccountingprinciples.
Reportingforregulators.
Theneedforconservatism.
Theneedsoftheusersoftheinformation.
AccordingtotheFASBconceptualframework,the
relevanceofprovidinginformationinfinancialstatements
issubjecttotheconstraintof
a. Comparability.
b. Costbenefit.
c. Reliability.
d. Faithfulrepresentation.
4.
a.
b.
d.
5.
a.
b.
c.
d.
6.
a.
b.
c.
d.
7.
businessenterprises.
The meaning of Present fairly in
accordance with generally accepted
accountingprinciples.
and
understandability.
Completeness, neutrality, and freedom from
error.
According to Statements of Financial
Accounting Concepts, neutrality is an
ingredientof
Faithful
representation
Yes
Yes
No
No
Relevance
Yes
No
Yes
No
AccordingtotheFASBconceptualframework,
whichofthefollowingisanenhancingquality
that relates to both relevance and faithful
representation?
Comparability.
Confirmatoryvalue.
Predictivevalue.
Freedomfromerror.
AccordingtotheFASBconceptualframework,the
processofreportinganiteminthefinancialstatementsof
anentityis
a. Allocation.
b. Matching.
c. Realization.
d. Recognition.
8.
UnderFASBStatementofFinancialAccounting
Concepts 5, which of the following items
would cause earnings to differ from
comprehensiveincomeforanenterpriseinan
industrynothavingspecializedaccountingprinciples?
a.
c.
d.
9.
a.
b.
c.
10. Thefundamentalqualitativecharacteristicof
faithfulrepresentationhasthecomponentsof
a. Predictivevalueandconfirmatoryvalue.
b. Comparability, consistency, and
confirmatoryvalue.
c. Understandability, predictive value, and
reliability.
d. Completeness, neutrality, and freedom from
error.
11. AccordingtotheFASBconceptualframework,
whichofthefollowingstatementsconformsto
therealizationconcept?
a.
Equipmentdepreciationwasassignedto
a production department and then to
productunitcosts.
b.
c.
Cashwascollectedonaccountsreceivable.
d. Product unit costs were assigned to
cost of goods sold when the units
weresold.
12. Whatistheunderlyingconceptthatsupports
the immediate recognition of a contingent
loss?
a. Substanceoverform.
b. Consistency.
c. Matching.
d. Conservatism.
13. Whatistheunderlyingconceptgoverningthe
generallyacceptedaccountingprinciples
pertainingtorecordinggaincontingencies?
a. Conservatism.
b. Relevance.
c. Consistency.
d. Faithfulrepresentation.
14. FASBsconceptualframeworkexplainsboth
financialandphysicalcapitalmaintenance
concepts.Whichcapitalmaintenanceconceptis
appliedtocurrentlyreportednetincome,and
whichisappliedtocomprehensiveincome?
Currently
reportednetincome
Comprehensiveincome
a.
Financialcapital
Physicalcapital
b.
Physicalcapital
Physicalcapital
c.
Financialcapital
Financialcapital
d.
Physicalcapital
Financialcapital
15.AccordingtotheFASBconceptualframework,an
entitysrevenuemayresultfrom
a. Adecreaseinanassetfromprimaryoperations.
b. An increase in an asset from incidental
transactions.
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
242
c.
d.
Anincreaseinaliability
from incidental transac
tions.
A decrease in a liability from
primaryoperations.
16. AccordingtotheFASBconceptual
framework,whichofthefollowing
isanessentialcharacteristicofan
asset?
a. The claims to an
assets benefits are
legallyenforceable.
b. Anassetistangible.
c. Anassetisobtainedatacost.
d. Anassetprovidesfuturebenefits.
17. AccordingtotheFASBconceptual
framework,whichofthefollowing
attributeswouldnotbeusedto
measureinventory?
a. Historicalcost.
b. Replacementcost.
c. Netrealizablevalue.
d. Presentvalueoffuturecashflows.
18. AccordingtoSFAC7,UsingCash
FlowInformationandPresentValue
inAccountingMeasurements,the
mostrelevantmeasurementofan
entitysliabilitiesatinitialrec
ognitionandfreshstart
measurementsshouldalwaysreflect
a. The expectations of the entitys
management.
b. Historicalcost.
c. Thecreditstandingoftheentity.
d. The single mostlikely
minimum or maximum
possibleamount.
19. Whichofthefollowingisnotcoveredby
SFAC7,UsingCashFlowInformationand
PresentValueinAccountingMeasurements?
a. Measurementsatinitialrecognition.
b. Interestmethodofamortization.
c. Expectedcashflowapproach.
d. Determining when
freshstart
measurements are
appropriate.
20. In calculating present value in a
situation with a range of possible
outcomesalldiscountedusingthe
same interest rate, the expected
presentvaluewouldbe
a. Themostlikelyoutcome.
b. Themaximumoutcome.
c. Theminimumoutcome.
d. The sum of probabilityweighted
presentvalues.
21. Acashflowof$200,000maybe
receivedbyLydiaNickels,Inc.in
oneyear,twoyears,orthreeyears,
withprobabilitiesof20%,50%,
and30%,respectively.Therateof
interestondefaultriskfree
investmentsis5%.Thepresent
valuefactorsare
PVof1,at5%,for1yearis
PVof1,at5%,for2yearsis
PVof1,at5%,for3yearsis
.95238
.90703
.86384
Whatistheexpectedpresentvalueof
LydiaNickelscashflow(inwhole
dollars)?
a. $181,406
b. $180,628
c. $90,703
d. $89,925
22. Which of the following
statements regarding interest
methods of allocations is not
true?
a.
Theterminterestmethods
ofallocationrefersbothto
theconventionforperiodic
reportingandto
theseveralapproachestodealing
withchangesinestimatedfuture
cashflows.
b. Interest methods of
allocation are reporting
conventions that use
present value techniques
intheabsenceofafresh
start measurement to
compute changes in the
carrying amount of an
asset or liability from
oneperiodtothenext.
c. Interest methods of
allocationaregroundedin
thenotionofcurrentcost.
d. Holdinggainsandlosses
are generally excluded
fromallocationsystems.
a.
b.
c.
d.
delivery,andtheremaining25%
dueonseconddelivery.What
amountofrevenueshouldAcme
recognizefromthissaleduring
2010?
$75,000
$150,000
$225,000
$300,000
27. AmarFarmsproduced300,000poundsof
cottonduringthe2010season.Amarsellsall
ofitscottontoBryeCo.,whichhasagreedto
purchaseAmarsentireproductionatthe
prevailingmarketprice.Recentlegislation
assuresthatthemarketpricewillnotfall
below$.70perpoundduringthenexttwo
years.Amarscostsofsellinganddistributing
thecottonareimmaterialandcanbe
reasonablyestimated.Amarreportsits
inventoryatexpectedexitvalue.During2010,
23. Whichofthefollowingisnotan
AmarsoldanddeliveredtoBrye200,000
objectiveofusingpresentvalue
poundsatthemarketpriceof$.70.Amarsold
inaccountingmeasurements?
theremaining100,000poundsduring2011at
a. Tocapturethevalueofan
themarketpriceof$.72.Whatamountof
asset or a liability in the
revenueshouldAmarrecognizein2010?
context of a particular
a. $140,000
entity.
b. $144,000
b. Toestimatefairvalue.
c. Tocapturetheeconomic
difference between sets
offuturecashflows.
d. To capture the elements
that taken together would
compriseamarketpriceif
oneexisted.
24. OnDecember31,2010,BrooksCo.
decidedtoendoperationsand
disposeofitsassetswithinthree
months.AtDecember31,2010,the
netrealizablevalueoftheequip
mentwasbelowhistoricalcost.
Whatistheappropriate
measurementbasisforequipment
includedinBrooksDecember31,
2010balancesheet?
a. Historicalcost.
b. Currentreproductioncost.
c. Netrealizablevalue.
d. Currentreplacementcost.
25. Whichofthefollowingaccounting
literature is not included in the
FASB Accounting Standards
Codification?
a. AICPAStatementsofPosition.
b. FASBStatements.
c. AccountingResearchBulletins.
d. StatementsofAuditingStandards.
26. OnOctober1,2010,AcmeFuelCo.
sold100,000gallonsofheatingoil
toKarnCo.at$3pergallon.Fifty
thousandgallonsweredeliveredon
December15,2010,andthe
remaining50,000gallonswere
deliveredonJanuary15,2011.
Paymenttermswere:50%dueon
October1,2010,25%dueonfirst
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
c.
d.
$210,000
$216,000
28. LinCo.,adistributorofmachinery,
boughtamachinefromthe
manufacturerinNovember2010for
$10,000.OnDecember30,2010,
LinsoldthismachinetoZee
Hardwarefor$15,000,underthe
followingterms:2%discountifpaid
withinthirtydays,1%discountif
paidafterthirtydaysbutwithinsixty
days,orpayableinfullwithinninety
daysifnotpaidwithinthediscount
periods.However,Zeehadtheright
toreturnthismachinetoLinifZee
wasunabletoresellthemachine
beforeexpirationoftheninetyday
paymentperiod,inwhichcaseZees
obligationtoLinwouldbecan
celed.InLinsnetsalesfortheyear
endedDecember31,2010,how
muchshouldbeincludedforthesale
ofthismachinetoZee?
a. $0
b. $14,700
c. $14,850
d. $15,000
29. Underaroyaltyagreementwith
anothercompany,WandCo.will
payroyaltiesfortheassignmentof
apatentforthreeyears.The
royaltiespaidshouldbereported
asexpense
a. Intheperiodpaid.
b. Intheperiodincurred.
c. At the date the royalty agreement
began.
d. At the date the royalty agreement
expired.
30. ClarkCo.sadvertisingexpense
accounthadabalanceof$146,000
atDecember31,2010,beforeany
necessaryyearendadjustment
relatingtothefollowing:
Includedinthe$146,000isthe
$15,000costofprintingcatalogs
forasalespromotionalcampaignin
January2011.
Radioadvertisementsbroadcast
duringDecember2010werebilled
toClarkonJanuary2,2011.Clark
paidthe$9,000invoiceonJanuary
11,2011.
a.
b.
c.
d.
WhatamountshouldClarkreportasadvertising
expenseinitsincomestatementfortheyear
endedDecember31,2010?
$122,000
$131,000
$140,000
$155,000
31.AnanalysisofThriftCorp.s
unadjustedprepaidexpenseaccountat
December31,2010,revealedthefollow
ing:
243
Anopeningbalance of$1,500for
Thrifts
comprehensive
insurancepolicy.Thrifthadpaid
anannualpremiumof$3,000on
July1,2009.
A $3,200 annual insurance
premium payment made July 1,
2010.
A$2,000advancerentalpaymentfora
warehouseThriftleasedforoneyear
beginningJanuary1,2011.
InitsDecember31,2010balancesheet,
whatamountshouldThriftreportasprepaid
expenses?
a. $5,200
b. $3,600
c. $2,000
d. $1,600
32. Roro,Inc.paid$7,200to renew
its only insurance policy for
threeyearsonMarch1,2010,the
effectivedateof
merchandise,thatexpireoneyear
aftertheirissuance.Regalhasthe
followinginformationpertainingto
itsgiftcertificatessalesand
redemptions:
thepolicy.AtMarch31,2010,Roros
unadjustedtrialbalanceshowedabalanceof
$300forprepaidinsuranceand$7,200for
insuranceexpense.Whatamountsshouldbe
reportedforprepaidinsuranceandinsurance
expenseinRorosfinancialstatementsforthe
threemonthsendedMarch31,2010?
a.
b.
c.
d.
Prepaidinsurance
$7,000
$7,000
$7,200
$7,300
Insuranceexpense
$300
$500
$300
$200
33.AneensVideoMartsellsoneandtwo
yearmailordersubscriptionsforitsvideoof
themonthbusiness.Subscriptionsare
collectedinadvanceandcreditedtosales.An
analysisoftherecordedsalesactivityrevealed
thefollowing:
Sales
Lesscancellations
Netsales
Subscriptionsexpirations:
2009
2010
2011
2012
2009
$420,000
20,000
$400,000
$120,000
155,000
125,000
$400,000
InAneensDecember31,2010balance
sheet,thebalanceforunearnedsubscription
revenueshouldbe
a. $495,000
b. $470,000
c. $465,000
d. $340,000
34. RegalDepartmentStoresellsgift
certificates,redeemableforstore
Unredeemedat12/31/09
2010sales
2010redemptionsofprioryearsales
2010redemptionsofcurrentyearsales
$75,000
250,000
25,000
175,000
Regalsexperienceindicatesthat10%of
giftcertificatessoldwillnotberedeemed.
InitsDecember31,2010balancesheet,
whatamountshouldRegalreportas
unearnedrevenue?
a. $125,000
b. $112,500
c. $100,000
d. $50,000
$500,000
30,000
$470,000
$130,000
200,000
140,000
$470,000
74. WrenCorp.strademarkwaslicensed
toMontCo.forroyaltiesof15%of
salesofthetrademarkeditems.
Royaltiesarepayablesemiannually
onMarch15forsalesinJulythrough
Decemberoftheprioryear,andon
September15forsalesinJanuary
throughJuneofthesameyear.Wren
receivedthefollowingroyaltiesfrom
Mont:
2009
2010
March15
$10,000
12,000
September15
$15,000
17,000
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
244
c.
d.
39. CookeCompanyacquirespatent
rightsfromotherenterprisesand
paysadvanceroyaltiesinsome
cases,andinothers,royaltiesare
paidwithinninetydaysafteryear
end.Thefollowingdataare
includedinCookesDecember31
balancesheets:
$38,000
$41,000
36. In2009,SuperComicsCorp.solda
comicstriptoFantasy,Inc.and
willreceiveroyaltiesof20%of
futurerevenuesassociatedwiththe
comicstrip.AtDecember31,2010,
Superreportedroyaltiesreceivable
of$75,000fromFantasy.During
2011,Superreceivedroyalty
paymentsof$200,000.Fantasy
reportedrevenuesof$1,500,000in
2011fromthecomicstrip.Inits
2011incomestatement,what
amountshouldSuperreportas
royaltyrevenue?
a. $125,000
b. $175,000
c. $200,000
d. $300,000
Prepaidroyalties
Royaltiespayable
a.
b.
c.
d.
During 2010Cookeremittedroyalties of
$300,000.Initsincomestatementforthe
year ended December 31, 2010, Cooke
shouldreportroyaltyexpenseof
$295,000
$305,000
$310,000
$330,000
37. RillCo.ownsa20%royaltyinterest
inanoilwell.Rillreceivesroyalty
paymentsonJanuary31fortheoil
soldbetweenthepreviousJune1
andNovember30,andon
July31foroilsoldbetweenDecember1and
May 31. Production reports show the
followingoilsales:
June1,2009November30,2009
December1,2009 December31,2009
December1,2009 May31,2010
June1,2010November30,2010
December1,2010 December31,2010
WhatamountshouldRillreportasroyalty
revenuefor2010?
a. $140,000
b. $144,000
c. $149,000
d. $159,000
38. DeckerCompanyassignssomeofits
patentstootherenterprisesundera
varietyoflicensingagreements.In
someinstancesadvanceroyaltiesare
receivedwhentheagreementsare
signed,andinothers,royaltiesare
remittedwithinsixtydaysaftereach
licenseyearend.Thefollowingdata
areincludedinDeckersDecember
31balancesheet:
Royaltiesreceivable
Unearnedroyalties
2009
$90,000
60,000
During2010Deckerreceivedroyalty
remittancesof$200,000.Initsincome
statementfortheyearendedDecember
31,2010,Deckershouldreportroyalty
incomeof
a. $195,000
b. $215,000
c. $220,000
d. $225,000
2009
$55,000
80,000
2010
$85,000
40,000
2010
$45,000
75,000
40. Thepremiumonathreeyearinsurancepolicy
expiringonDecember31,2012,waspaidin
totalonJanuary1,2010.Theoriginal
paymentwasinitiallydebitedtoaprepaid
assetaccount.Theappropriatejournalentry
hasbeenrecordedonDecember31,2010.The
balanceintheprepaidassetaccounton
December31,2010,shouldbe
a. Zero.
b. Thesameasitwouldhavebeenif
theoriginalpaymenthadbeen
debitedinitiallytoanexpenseac
count.
c. Thesameastheoriginalpayment.
d. Higherthaniftheoriginal
payment had been deb
itedinitiallytoanexpense
account.
41. OnJanuary1,2010,SipCo.signed
afiveyearcontractenablingitto
useapatentedmanufacturing
processbeginningin2010.A
royaltyispayableforeachproduct
produced,subjecttoaminimum
annualfee.Anyroyaltiesinexcess
oftheminimumwillbepaid
annually.Onthecontractdate,Sip
prepaidasumequaltotwoyears
minimumannualfees.In2010,only
minimumfeeswereincurred.The
royaltyprepaymentshouldbe
reportedinSipsDecember31,
2010financialstatementsas
a. Anexpenseonly.
b. Acurrentassetandanexpense.
c. Acurrentassetandnoncurrentasset.
d. Anoncurrentasset.
42. Aretailstorereceivedcashand
issuedgiftcertificatesthatare
redeemableinmerchandise.The
giftcertificateslapseoneyearafter
theyareissued.Howwouldthede
ferredrevenueaccountbeaffected
byeachofthefollowing
transactions?
a.
b.
c.
d.
Redemptionofcertificates
Noeffect
Decrease
Decrease
Noeffect
Lapseofcertificates
Decrease
Decrease
Noeffect
Noeffect
43. Jersey,Inc.isaretailerofhome
appliancesandoffersaservice
contractoneachappliancesold.
Jerseysellsapplianceson
installmentcontracts,butallservice
contractsmustbepaidinfullatthe
timeofsale.Collectionsreceived
forservicecontractsshouldbe
recordedasanincreaseina
a. Deferredrevenueaccount.
b. Salescontractsreceivablevaluation
account.
c. Stockholdersvaluationaccount.
d. Servicerevenueaccount.
44. Ward,aconsultant,keepsher
accountingrecordsonacashbasis.
During2010,Wardcollected
$200,000infeesfromclients.At
December31,2009,Wardhad
accountsreceivableof$40,000.At
December31,2010,Wardhad
accountsreceivableof$60,000,and
unearnedfeesof$5,000.Onan
accrualbasis,whatwasWards
servicerevenuefor2010?
a. $175,000
b. $180,000
c. $215,000
d. $225,000
45. Zeta Co. reported sales revenue
of $4,600,000 in its income
statement for the year ended
December 31, 2010. Additional
informationisasfollows:
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
12/31/09
Accountsreceivable
$1,000,000
Allowanceforuncollectibleaccounts
(60,000)
Undertheaccrualbasis,Marrshouldreport
rentalrevenueof
a.
b.
c.
d.
$1,920,000
$1,980,000
$2,440,000
$2,500,000
47.Thefollowinginformationpertainsto
EagleCo.s2010sales:
Cashsales
Gross
Returnsandallowances
Creditsales
Gross
Discounts
$80,000
4,000
120,000
6,000
OnJanuary1,2010customersowedEagle
$40,000.OnDecember31,2010,customers
owedEagle$30,000.Eagleusesthedirect
writeoffmethodforbaddebts.Nobaddebts
wererecordedin2010.Underthecashbasis
ofaccounting,whatamountofnetrevenue
shouldEaglereportfor2010?
a. $76,000
b. $170,000
c. $190,000
d. $200,000
48. The following balances were
reported by Mall Co. at
December31,2010and2009:
Inventory
Accountspayable
12/31/10
$260,000
75,000
12/31/09
$290,000
50,000
Mallpaidsuppliers$490,000duringtheyear
endedDecember31,2010.Whatamount
shouldMallreportforcostofgoodssoldin
2010?
a. $545,000
b. $495,000
c. $485,000
d. $435,000
245
49. ClassCorp.maintainsitsaccounting
recordsonthecashbasisbutrestates
itsfinancialstatementstothe
accrualmethodofaccounting.Class
had$60,000incashbasispretax
incomefor2010.Thefollowing
informationpertainstoClasss
operationsfortheyearsended
December31,2010and2009:
Accountsreceivable
Accountspayable
2010
$40,000
15,000
2009
$20,000
30,000
d.
Undertheaccrualmethod,whatamountof
incomebeforetaxesshouldClassreportin
itsDecember31,2010incomestatement?
a. $25,000
b. $55,000
c. $65,000
d. $95,000
50. OnFebruary1,2011,Torybeganaservice
proprietorshipwithaninitialcashinvestment
of$2,000.Theproprietorshipprovided
$5,000ofservicesinFebruaryandreceived
fullpaymentinMarch.Theproprietorship
incurredexpensesof$3,000inFebruary,
whichwerepaidinApril.DuringMarch,Tory
drew$1,000againstthecapitalaccount.In
theproprietorshipsfinancialstatementsfor
thetwomonthsendedMarch31,2011,
preparedunderthecashbasismethodof
accounting,whatamountshouldbereported
ascapital?
a. $1,000
b. $3,000
c. $6,000
d. $7,000
51. Comparedtothe accrualbasisof
accounting, the cash basis of
accountingunderstatesincomeby
the net decrease during the
accountingperiodof
a.
b.
c.
Accountsreceivable
Yes
Yes
No
No
Yes
52.WhiteCo.wantstoconvertits2010
financialstatementsfromtheaccrualbasis
ofaccountingtothecashbasis.Bothsupplies
inventoryandofficesalariespayablein
creasedbetweenJanuary1,2010,and
December31,2010.Toobtain2010cash
basisnetincome,howshouldtheseincreases
beaddedtoordeductedfromaccrualbasis
netincome?
a.
b.
c.
d.
Suppliesinventory
Deducted
Deducted
Added
Added
Officesalariespayable
Deducted
Added
Deducted
Added
53.Before2010,DroitCo.usedthecash
basisofaccounting.AsofDecember31,
2010,Droitchangedtotheaccrualbasis.
Droitcannotdeterminethebeginningbalance
ofsuppliesinventory.Whatistheeffectof
Droitsinabilitytodeterminebeginning
suppliesinventoryonits2010accrualbasis
netincomeandDecember31,2010accrual
basisownersequity?
a.
b.
c.
d.
2010netincome
Noeffect
Noeffect
Overstated
Overstated
12/31/10ownersequity
Noeffect
Overstated
Noeffect
Overstated
54.GantCo.,whichbeganoperationson
Accruedexpenses
January1,2010,appropriatelyusesthe
Yes
installmentmethodofaccounting.The
No
followinginformationpertainstoGants
No
operationsfortheyear2010:
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
246
Grossprofitpercentages
Whatamountofinstallmentaccounts
$500,000
receivableshouldDolcereportinits
December31,2011balancesheet?
Installmentsales
Regularsales
Costofinstallmentsales
Costofregularsales
Generalandadministrativeexpenses
Collectionsoninstallmentsales
InitsDecember31,2010balancesheet,what
amountshouldGantreportasdeferredgross
profit?
a. $250,000
b. $200,000
c. $160,000
d. $75,000
a.
b.
c.
d.
55. Sincethereisnoreasonable
basisforestimatingthedegree
ofcollectibility,AstorCo.uses
theinstallmentmethodof
revenuerecognitionforthe
followingsales:
Sales
Collectionsfrom:
2009sales
2010sales
Accountswrittenoff:
2009sales
2010sales
Grossprofitpercentage
2010
$900,000
2009
$600,000
100,000
300,000
200,000
150,000
50,000
40%
50,000
WhatamountshouldAstorreportasdeferred
grossprofitinitsDecember31,2010balance
sheetforthe2009and2010sales?
a. $150,000
b. $160,000
c. $225,000
d. $250,000
56. LugeCo.,whichbeganoperations
onJanuary 2,2010, appropriately
uses the installment sales method
of accounting. The following
informationisavailablefor2011:
Installmentaccountsreceivable,December31,2011
Deferredgrossprofit,December31,2011(before
recognitionofrealizedgrossprofitfor2011)
Grossprofitonsales
FortheyearendedDecember31,2011,cash
collectionsandrealizedgrossprofitonsales
shouldbe
a.
b.
c.
d.
Cashcollections
$400,000
$400,000
$600,000
$600,000
Realizedgrossprofit
$320,000
$240,000
$320,000
$240,000
57.DolceCo.,whichbeganoperationson
January1,2010,appropriatelyusesthe
installmentmethodofaccountingtorecord
revenues.Thefollowinginformationis
availablefortheyearsendedDecember31,
2010and2011:
Sales
Grossprofitrealizedonsales
madein:
2010
2011
2010
$1,000,000
150,000
$1,225,000
$1,300,000
$1,700,000
$1,775,000
30%
40%
cost of sales
have been
received.
58. OnDecember31,2010,MillCo.
soldconstructionequipmentto
Drew,Inc.for$1,800,000.The
equipmenthadacarryingamountof
$1,200,000.Drewpaid$300,000
cashonDecember31,2010,and
signeda$1,500,000notebearing
interestat10%,payableinfive
annualinstallmentsof$300,000.
Millappropriatelyaccountsforthe
saleundertheinstallmentmethod.
OnDecember31,2011,Drewpaid
$300,000principaland$150,000
interest.Fortheyearended
December31,2011,whattotal
amountofrevenueshouldMill
recognizefromtheconstruction
equipmentsaleandfinancing?
a. $250,000
b. $150,000
c. $120,000
d. $100,000
59. OnJanuary2,2010,BlakeCo.soldaused
machinetoCooper,Inc.for$900,000,
resultinginagainof$270,000.Onthatdate,
Cooperpaid$150,000cashandsigneda
$750,000notebearinginterestat10%.The
notewaspayableinthreeannualinstallments
of$250,000beginningJanuary2,2011.Blake
appropriatelyaccountedforthesaleunderthe
installmentmethod.Coopermadeatimely
paymentofthefirstinstallmentonJanuary2,
2011,of$325,000,whichincludedaccrued
interestof$75,000.Whatamountofdeferred
grossprofitshouldBlakereportatDecember
31,2011?
a. $150,000
b. $172,500
c. $180,000
d. $225,000
60. For financial statement
purposes, the installment
methodofaccountingmaybe
usedifthe
a. Collection
period extends
overmorethan
twelvemonths.
b. Installments are due in different
years.
c. Ultimate amount collectible is
indeterminate.
d. Percentageofcompletion method is
inappropriate.
61. Accordingtotheinstallmentmethod
ofaccounting,grossprofitonan
installmentsaleisrecognizedin
income
a.
b.
c.
Onthedateofsale.
Onthedatethefinalcashcollection
isreceived.
Inproportiontothecashcollection.
d. After cash
collections
equal to the
62. Incomerecognizedusingthe
installmentmethodofaccounting
generallyequalscashcollected
multipliedbythe
a.
c.
Netoperatingprofitpercentage.
b. Net operating
profit
percentage
adjusted for
expected
uncollectible
accounts.
Grossprofitpercentage.
d. Gross profit
percentage
adjusted for
expected un
collectible
accounts.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
NeitherInorII.
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
247
agreement,thenonrefundabledownpayment
representsafairmeasureoftheservices
alreadyperformedbyRice;however,
64.Thefollowinginformationpertainsto
substantialfutureservicesarerequiredof
asaleofrealestatebyRyanCo.toSud
Rice.Collectibilityofthenoteisreasonably
Co.onDecember31,2010:
certain.InRicesDecember31,2010balance
Carryingamount
$2,000,000
sheet,unearnedfranchisefeesfromGrafs
Salesprice:
franchiseshouldbereportedas
Cash
$300,000
Purchasemoneymortgage
2,700,000
a. $132,000
b. $100,000
Themortgageispayableinnineannual
c. $90,000
installmentsof$300,000beginningDecember
d. $72,000
31,2011,plusinterestof10%.TheDecember
31,2011,installmentwaspaidasscheduled,
68. EachofPotterPieCo.stwentyone
togetherwithinterestof$270,000.Ryanuses
newfranchiseescontractedtopay
thecostrecoverymethodtoaccountforthe
aninitialfranchisefeeof$30,000.
sale.WhatamountofincomeshouldRyan
ByDecember31,2010,each
recognizein2011fromtherealestatesale
franchiseehadpaidanonrefund
anditsfinancing?
able$10,000feeandsignedanote
a. $570,000
topay$10,000principalplusthe
b. $370,000
marketrateofinterestonDecember
c. $270,000
31,2011,andDecember31,2012.
d. $0
Experienceindicatesthatone
franchiseewilldefaultonthe
65. WrenCo.sellsequipmenton
additionalpayments.Servicesfor
installmentcontracts.Whichofthe
theinitialfeewillbeperformedin
followingstatementsbestjustifies
2011.Whatamountofnet
Wrensuseofthecostrecovery
methodofrevenuerecognitionto
accountfortheseinstallment
sales?
a. Thesalescontract
providesthattitletothe
equipmentonlypasses
tothepurchaserwhenall
paymentshavebeen
made.
b. No cash payments are
due until one year from
thedateofsale.
c. Sales are subject to a high rate of
return.
d. There is no reasonable basis for
estimatingcollectibility.
66. According to the cost recovery
methodofaccounting,grossprofit
on an installment sale is
recognizedinincome
a. After cash collections
equal to the cost of
sales have been
received.
b. Inproportiontothecashcollections.
c. Onthedatethefinalcashcollection
isreceived.
d. Onthedateofsale.
67. OnDecember31,2010,Rice,Inc.authorized
Graftooperateasafranchiseeforaninitial
franchisefeeof$150,000.Ofthisamount,
$60,000wasreceiveduponsigningthe
agreementandthebalance,representedbya
note,isdueinthreeannualpaymentsof
$30,000eachbeginningDecember31,2011.
ThepresentvalueonDecember31,2010,of
thethreeannualpaymentsappropriately
discountedis$72,000.Accordingtothe
unearnedfranchisefeeswouldPotterreportat
December31,2010?
a. $400,000
b. $600,000
c. $610,000
d. $630,000
69. Inwhichofthefollowingexamples
ofrealestatetransactionswould
thesellernottransfertheusualrisks
andrewardsofownership?
I.
Thebuyercancompelthesellerto
repurchasetheproperty.
AI. The seller guarantees the return of the
buyersinvestment.
BI. The seller is required to
supportoperationsofthe
buyer and will be
reimbursedonacostplus
5%basis.
a.
b.
c.
d.
I.
II.
III.
IandII.
70. EskerInc.specializesinrealestate
transactionsotherthanretailland
sales.OnJanuary1,2011,Esker
consummatedasaleofpropertyto
KameLtd.Theamountofprofiton
thesaleisdeterminableandEskeris
notobligatedtoperformany
additionalactivitiestoearnthe
profit.Kamesinitialand
continuinginvestmentswere
adequatetodemonstratea
commitmenttopayfortheproperty.
However,Eskersreceivablemay
besubjecttofuturesubordination.
Eskershouldaccountforthesale
usingthe
a. Depositmethod.
b. Reducedrecoverymethod.
c. Costrecoverymethod.
d. Fullaccrualmethod.
71. Whichofthefollowingisoneof
theconditionsthatmustexistfora
companytorecognizerevenueon
separateunitsunderamultiple
deliverablesarrangement?
a. The
deliver
ed
item
has
value
on a
stand
alone
basis
and
can be
sold
separat
ely.
b. Thedelivereditemisnotreturnable.
c. Co
d.
lle
cti
on
ha
s
oc
cu
rre
d
for
all
of
th
e
se
pa
rat
e
un
its.
The
sep
arat
e
unit
s
mu
st
be
deli
ver
ed
wit
hin
90
day
sof
the
end
of
the
acc
oun
ting
peri
od.
b.
amo
unt
of
cash
colle
cted.
A
provisi
ons
rata
share
of
revenu
e
based
c.
d.
upon
the
percen
tage
deliver
ed to
date.
Contingentrevenueisrecognizedin
itsentirety.
Apercentageoftotalrevenuebased
ontheseparateunitsdelivered.
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
248
a.
b.
c.
d.
1
3
4
1
2
3
4
AccordingtotheIASBFramework,thetwo
criteriarequiredforincorporatingitemsinto
theincomestatementorstatementoffinancial
positionarethat
1 It meets the definition of
relevance and faithful
representation.
2 Itmeetsthedefinitionofan
element and can be
measuredreliably.
3 It satisfies the criteria of capital
maintenance.
4 Itmeetstherequirementsof
comparability
and
consistency.
1
2
3
4
reliably,IFRS requirestheuse
of which revenue recognition
method?
Percentageofcompletionmethod.
Completedcontractmethod.
Costrecoverymethod.
Installmentmethod.
Which of the following is not
one of the criteria for revenue
recognition for sales of goods
underIFRS?
1 The significant risks and
rewards of ownership of
goodsaretransferred.
Paymenthasbeenreceived.
3
Theentitydoesnotretaineither
acontinuingmanagerial
involvementorcontroloverthe
goods.
Thecostsincurredcanbemeasured
reliably.
UnderIFRS,whichofthe
followingisthefirststepwithin
thehierarchyofguidanceto
whichmanagementrefers,and
whoseapplicabilityitconsiders,
whenselectingaccounting
policies?
a.
b.
Considerthemostrecent
pronouncementsofother
standardsettingbodiesto
theextenttheydonot
conflictwiththeIFRSorthe
IASBFramework.
Apply a standard from
IFRS if it specifically re
lates to the transaction,
otherevent,orcondition.
c.
d.
Considertheapplicability
ofthedefinitions,rec
ognitioncriteria,and
measurementconceptsin
theIASBFramework.
Apply the requirements in IFRS
dealing with similar and related
issues.
82. OnJuly1,year2,acompany
decidedtoadoptIFRS.The
companysfirstIFRSreporting
periodisasofandfortheyear
endedDecember31,year2.The
companywillpresentoneyearof
comparativeinformation.Whatis
thecompanysdateoftransitionto
IFRS?
a.
b.
c.
d.
January1,year1.
January1,year2.
July1,year2.
December31,year2.
83. Howshouldafirsttimeadopterof
IFRS recognize the adjustments
required to present its opening
IFRS statement of financial
position?
a. Alloftheadjustments
should be recognized
inprofitorloss.
b. Adjustmentsthatare
capitalinnatureshouldbe
recognizedinretained
earningsandadjustments
thatarerevenueinnature
shouldberecognizedin
profitorloss.
c. Currentadjustmentsshouldbe
recognizedinprofitorlossand
noncurrentadjustmentsshouldbe
recognizedinretainedearnings.
d. All of the adjustments
should be recognized
directly in retained
earnings or, if
appropriate, in another
categoryofequity.
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
SIMULATIONS
TaskBasedSimulation1
Account
Classifications
Authoritative
Literature
Help
SupposeWinstonincorporatedandhadthefollowingaccounts.Indicatehoweachofthe
followingisclassifiedonthefinancialstatements.Belowisalistofclassifications.
Balancesheetclassification
A. Currentasset
B. Noncurrentasset
C. Currentliability
D. Noncurrentliability
E. Ownersequity
F. Contraasset
G. Contraequity
Incomestatementclassifications
H. Revenue
I. Expense
J. Contrarevenue
Balancesheetclassification
(A)(B)(C)(D)(E)(F)(G)
Incomestatementclassification
(H)(I)(J)
1. Bondspayable,duein2018
2. Treasurystock
3. Accountspayable
4. Salesdiscounts
5. Notespayable,dueinninemonths
6. Inventory
7. Accountsreceivable
8. Commonstock
9. Costofgoodssold
10. Allowanceforuncollectibleaccounts
TaskBasedSimulation2
AccrualBasis
Worksheet
Authoritative
Literature
Help
ThefollowinginformationpertainstoBaronFlowers,acalendaryearsoleproprietorship,
whichmaintaineditsbooksonthecashbasisduringtheyear.
BaronFlowers
TRIALBALANCE
December31,2010
Cash
Accountsreceivable,12/31/09
Inventory,12/31/09
Furniture&fixtures
Landimprovements
Accumulateddepreciation,12/31/09
Accountspayable,12/31/09
Baron,Drawings
Baron,Capital,12/31/09
Sales
Purchases
Salaries
Payrolltaxes
Insurance
Rent
Utilities
Livingexpenses
Dr.
$ 25,600
16,200
62,000
118,200
45,000
305,100
174,000
12,400
8,700
34,200
12,600
13,000
$827,000
Cr.
$32,400
17,000
124,600
653,000
______
$827,000
249
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
250
Baronhasdevelopedplanstoexpandintothewholesaleflowermarketandisintheprocessofnegotiatingabankloanto
financetheexpansion.Thebankisrequesting2010financialstatementspreparedontheaccrualbasisofaccountingfrom
Baron.Duringthecourseofareviewengagement,Muir,Baronsaccountant,obtainedthefollowingadditionalinformation.
1.
2.
3.
Amountsduefromcustomerstotaled$32,000atDecember31,2010.
vided.
Ananalysisoftheabovereceivablesrevealedthatanallowanceforuncollectibleaccountsof$3,800shouldbepro
Unpaidinvoicesforflowerpurchasestotaled$30,500and$17,000,atDecember31,2010,andDecember31,2009,re
spectively.
4.
Theinventorytotaled$72,800basedonaphysicalcountofthegoodsatDecember31,2010.Theinventorywas
pricedatcost,whichapproximatesmarketvalue.
5.
OnMay1,2010,Baronpaid$8,700torenewitscomprehensiveinsurancecoverageforoneyear.Thepremiumonthe
previouspolicy,whichexpiredonApril30,2010,was$7,800.
6.
OnJanuary2,2010,BaronenteredintoatwentyfiveyearoperatingleaseforthevacantlotadjacenttoBaronsretail
storeforuseasaparkinglot.Asagreedinthelease,Baronpavedandfencedinthelotatacostof$45,000.The
improvementswerecompletedonApril1,2010,andhaveanestimatedusefullifeoffifteenyears.Noprovisionfor
depreciationoramortizationhasbeenrecorded.Depreciationonfurnitureandfixtureswas$12,000for2010.
7.
AccruedexpensesatDecember31,2009and2010,wereasfollows:
2009
900
1,100
$2,000
Utilities
Payrolltaxes
2010
$1,500
1,600
$3,100
8.
Baronisbeingsuedfor$400,000.Thecoverageunderthecomprehensiveinsurancepolicyislimitedto$250,000.Barons
attorneybelievesthatanunfavorableoutcomeisprobableandthatareasonableestimateofthesettlementis$300,000.
9.
Thesalariesaccountincludes$4,000permonthpaidtotheproprietor.Baronalsoreceives$250perweekforliving
expenses.
Usingtheworksheetbelow,preparetheadjustmentsnecessarytoconvertthetrialbalanceofBaronFlowerstotheaccrual
basisofaccountingfortheyearendedDecember31,2010.Formaljournalentriesarenotrequiredtosupportyouradjustments.
However,usethenumbersgivenwiththeadditionalinformationtocrossreferencethepostingsintheadjustmentcolumnson
theworksheet.
BaronFlowers
WORKSHEETTOCONVERTTRIALBALANCETOACCRUALBASIS
December31,2010
Accounttitle
Cash
Accountsreceivable
Inventory
Furniture&fixtures
Landimprovements
Accumulateddepreciation
&amortization
Accountspayable
Baron,Drawings
Baron,Capital
Sales
Purchases
Salaries
Payrolltaxes
Insurance
Rent
Utilities
Livingexpenses
Cashbasis
Dr.
Cr.
25,600
16,200
62,000
118,200
45,000
32,400
17,000
124,600
653,000
305,100
174,000
12,400
8,700
34,200
12,600
13,000
827,000
*Completionofthesecolumnsisnotrequired.
827,000
Adjustments
Dr.
Cr.
Dr.*
Accrualbasis*
Cr.
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
251
TaskBasedSimulation3
Concepts
Authoritative
Literature
Help
ThisquestionconsistsoftenitemsthatrepresentdescriptionsordefinitionsofthevariouselementsoftheFASBs
StatementsofFinancialAccountingConcepts.SelectthebestanswerforeachitemfromthetermslistedinAL.Aterm
maybeusedonce,morethanonce,ornotatall.
Terms
A. Recognition
G. Gains
B. ComprehensiveIncome
H. NetIncome
C. Faithfulrepresentation
I. Earnings
D. Revenues
J. Realization
E. PredictiveValue
K. ReplacementCost
F. Comparability
L. CurrentMarketValue
1.
2.
3.
4.
5.
C
o
C
I
n
T
h
E
n
T
h
6.
7.
Allchangesinnetassetsofanentityduringaperiodexceptthoseresultingfrominvestmentsbyownersanddistributionsto
owners.
Inflowsorotherenhancementsofassetsofanentityorsettlementsofitsliabilitiesfromdeliveringorproducinggoods,
renderingservices,orotheractivitiesthatconstitutetheentitysongoingoperations.
8.
9.
Theamountofcash,oritsequivalent,thatcouldbeobtainedbysellinganassetinorderlyliquidation.
Thequalityofinformationthathelpsuserstoincreasethelikelihoodofcorrectlyforecastingtheoutcomeofpastor
presentevents.
10. Aperformancemeasureconcernedprimarilywithcashtocashcycles.
TaskBasedSimulation4
TrialBalance
Worksheet
Authoritative
Literature
Help
TheaccountslistedbelowappearedintheDecember31trialbalanceofJaneAlexanderTheater.
Equipment
Accumulateddepreciationequipment
Notespayable
Admissionsrevenue
Advertisingexpense
Salariesexpense
Interestexpense
192,000
13,680
57,600
1,400
60,000
90,000
380,000
Additionalinformationfollows:
1.
Theequipmenthasanestimatedlifeof16yearsandasalvagevalueof$40,000attheendofthattime.(Usestraightline
method.)
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
252
2.
3.
4.
5.
Thenotepayableisa90daynotegiventothebankOctober20andbearinginterestat10%.(Use360daysforde
nominator.)
InDecember,twothousand(2,000)couponadmissionbooksweresoldat$25each.Theycouldbeusedforadmission
anytimeafterJanuary1.
AdvertisingexpensepaidinadvanceandincludedinAdvertisingExpense,$1,100.
Salariesaccruedbutunpaid,$4,700.
UsingtheattachedExcelfile,completetheadjustments,adjustedtrialbalance,andtheincomestatementcolumnsofthe
worksheet.Forthe#column,insertthenumberofadjustments.Addaccountsasneeded.
JaneAlexanderTheater
December31,200X
a)
Equipment
Accumulateddepreciation
equipment
Notespayable
Admissionsrevenue
Advertisingexpense
Salariesexpense
Interestexpense
Depreciationexpense
Interestpayable
Unearnedadmissionsrevenue
Revenue
Prepaidadvertising
Salariespayable
Trialbalance
Debit
Credit
192,000
13,680
57,600
1,400
Adjustments
Debit
Credit
Adjustedtrialbalance
Debit
Credit
Incomestatement
Debit
Credit
60,000
90,000
380,000
TaskBasedSimulation5
Concepts
Authoritative
Literature
Help
SFAC5providesguidanceonmeasuringassetsandliabilities.Thefollowingmeasurementmethodsareavailableto
measureassetsandliabilities,asshowninthelistbelow.Identifytheappropriatevaluationmethodforeachitem.
A
1.
2.
3.
4.
5.
6.
7.
8.
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
253
TaskBasedSimulation6
Adjusting
Authoritative
Literature
Entries
Help
Indicatewhethereachofthefollowingadjustingentriesisanaccrualoradeferraltypeentry.
1.
Depreciationexpense
Accumulateddeprecation
xx
2.
Interestreceivable
Interestrevenue
xx
3.
Rentexpense
Prepaidrent
xx
4.
Unearnedrevenue
Rentrevenue
xx
5.
Wageexpense
Wagespayable
xx
Accrual
Deferral
xx
xx
xx
xx
xx
TaskBasedSimulation7
RevenueandExpense
Recognition
Authoritative
Literature
Help
Emcohasthefollowingtransactionsin2010.Indicatetheamountofrevenueorexpenserecognizedin2010,2011,and
2012foreachoftheseitems.Youmayshowexpenserecognitionsinparentheses(xx).
1.
Emcosells$5,000ofgoodstoacustomer,FOBshippingpointon12/30/10.
2.
Emcosellsthreepiecesofequipmentonacontractoverathreeyearperiod.
Thesalespriceofeachpieceofequipmentis$10,000.Deliveryofeach
pieceofequipmentisonFebruary10ofeachyear.In2010,thecustomer
paida$20,000downpayment,andpaid$5,000peryearin2011and2012.
Collectibilityisreasonablyassured.
3.
In1/1/10,Emcopays$9,000foramembershiptoWholesalersAssociation
foratwoyearmembershipinthetradeassociation.
4.
On6/1/10,Emcosignsacontractfor$20,000forgoodstobesoldon
account.Paymentistobemadeintwoinstallmentsof$10,000eachon
12/1/11and12/1/12.Thegoodsaredeliveredon10/1/10.Collectionis
reasonablyassured,andthegoodsmaynotbereturned.
5.
EmcosellsgoodstoacustomeronJuly1,2010,for$50,000.Ifthecustomer
doesnotsellthegoodstoretailcustomersbyDecember31,2011,thegoods
canbereturnedtoEmco.Thecustomersellsthegoodstoretailcustomerson
October1,2011.
MODULE9
254
BASICTH.&FIN.REP.:A.BASICCONCEPTS
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
c
d
b
c
b
a
d
a
c
d
b
d
a
c
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
d
d
b
c
a
c
d
b
c
a
b
c
b
b
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
Amountstoberecognized2010
20112012
37. c
38. b
39. b
40. b
41. b
42. b
43. a
44. c
45. d
46. d
47. d
48. a
49. d
50. c
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
55. d
56. d
57. c
58. a
59. a
60. c
61. c
62. c
63. d
64. d
65. d
66. a
67. d
68. c
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
73.
74.
75.
76.
77.
78.
79.
80.
81.
82.
83.
c
d
c
b
b
c
b
c
b
a
d
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
15.
16.
17.
18.
d
d
d
c
__
__
__
__
__
__
__
__
33.
34.
35.
36.
c
d
a
d
__
__
__
__
__
__
__
__
51.
52.
53.
54.
d
b
c
b
__
__
__
__
__
__
__
__
69.
70.
71.
72.
d
c
a
b
__
__
__
__
__
__
__
__
1st:
2nd:
__/83=__%
__/83=__%
MULTIPLECHOICEANSWEREXPLANATIONS
A.1.BasicAccountingTheory
1.
2.
3.
4.
(c)TheStatementsofFinancialAccountingCon
cepts(SFAC)wereissuedtoestablisha
frameworkfromwhichfinancialaccountingand
reportingstandardscouldbedeveloped.The
SFACprovidethetheorybehindaccountingand
reportingandprovideguidancewhennoGAAP
exists.TheSFACarenotincludedasGAAP.
(d)PerSFAC8,theobjectivesoffinancial
reportingfocusonprovidingpresentandpotential
investorsandcreditorswithinformationusefulin
makinginvestmentdecisions.Financialstatement
usersdonothavetheauthoritytoprescribethe
datatheydesire.Therefore,theymustrelyonex
ternalfinancialreportingtosatisfytheir
informationneeds,andtheobjectivesmustbe
basedontheneedsofthoseusers.
(b)TheFASBconceptualframeworkhasidentifiedthecost
benefitconstrainttotherelevanceofprovidingfinancial
reports.Informationisnotdisclosedifthecostsof
8.
disclosureoutweighthebenefitsofprovidingtheinforma
tion.Comparabilityisanenhancingqualitativecharacteris
tic.Reliabilityisnolongerpartoftheconceptualframework
accordingtoSFAC8.Faithfulrepresentationisafundamen
talqualitativecharacteristic.
(c)Theenhancingqualitativecharacteristicsoffinancial
reportingarecomparability(includingconsistency),
verifiability,timeliness,andunderstandability.Answer(a)is
incorrectbecauserelevanceandfaithfulrepresentationare
fundamentalqualitativecharacteristicsoffinancialinforma
tion.Reliabilityisnolongerlistedasafundamentalquality.
Answer(b)isincorrectbecausecostbenefitisaconstraint,
andmaterialityisathresholdforreportingusefulinforma
tion.Answer(d)isincorrectbecausecompleteness,neutral
ity,andfreedomfromerrorarecharacteristicsoffaithful
representation,afundamentalqualitativecharacteristic.
5.
componentsoffaithfulrepresentationincludeinformationto
beverifiableandfreefromerror.Neutralityisnotaningre
dientofrelevancebecauserelevancerequiresinformationto
havepredictivevalueandconfirmatoryvalue,orboth.
6.
(a)PerSFAC8,comparabilityisanenhancing
qualityoffinancialreportingwhichrelatestoboth
relevanceandfaithfulrepresentation.
Confirmatoryvalueandpredictivevalueonly
relatetorelevance.Freedomfromerroronlyre
latestofaithfulrepresentation.
7.
(d)PerSFAC5,recognitionistheprocessoffor
mallyrecordingorincorporatinganitemintothe
financialstatementsasanasset,liability,revenue,
expense,orthelike.AccordingtoSFAC6,allocation
istheprocessofassigningordistributinganamount
accordingtoaplanorformula,matchingisthe
simultaneousrecognitionofrevenueswithexpenses
thatarerelateddirectlyorjointlytothesametrans
actionsorevents,andrealizationistheprocessof
convertingnoncashresourcesandrightsintomoney.
(a)PerSFAC5,earningsandcomprehensiveincomehavethe
samebroadcomponentsrevenues,expenses,gains,andlosses
butarenotthesamebecausecertainclassesofgainsand
lossesareexcludedfromearnings.Changesinmarketvaluesof
investmentsinmarketableequitysecuritiesclassifiedas
availableforsalesecuritiesareincludedincomprehensive
income,butareexcludedfromearningsuntilrealized.Answers
(b),(c),and(d)areincorrectbecausetheywouldbeincludedin
bothearningsandcomprehensiveincome.Notethatunrealized
gainsandlossesonmarketableequitysecuritiesclassifiedas
tradingsecuritiesareincludedinearnings.Thistreatmentisin
accordancewithSFAS115.
(b)SFAC8definesneutralityasthequalityof
informationwhichrequiresfreedomfrombias
towardapredeterminedresult.Unbiased
informationwouldalwaysbemorefaithfully
representedthanbiasedinformation.Other
9.
(c)PerSFAC6,comprehensiveincomeincludes
allchangesinequityduringaperiodexceptthose
resultingfrominvestmentsbyownersand
distributionstoowners.Dividendspaidto
stockholdersisachangeinequityresultingfroma
distributiontoowners,soitisexcludedfromcom
prehensiveincome.Answers(a),(b),and(d)are
allincludedincomprehensiveincomebecause
theyarechanges
Explanationofhowtousethisperformancerecordappearsonpage2.
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
inequity,butarenotinvestmentsby,ordistributions
to,owners.
10. (d)Thefundamentalqualitativecharacteristicof
faithfulrepresentationhasthecomponentsof
completeness,neutrality,andfreedomfromerror.
Answer(a)isincorrectbecausepredictivevalue
andconfirmatoryvaluearethecomponentsof
relevance.Answer(b)isincorrectbecause
comparabilityandconsistencyareenhancing
characteristics,andconfirmatoryvalueisa
componentofrelevance.Answer(c)isincorrect,
255
becauseunderstandabilityisanenhancing
characteristic,predictivevalueisacomponentof
relevance,andreliabilityisnolongera
characteristicintheconceptstatements.
11. (b)AccordingtoSFAC6,realizationistheprocess
ofconvertingnoncashresourcesandrightsinto
moneythroughthesaleofassetsforcashorclaims
tocash.Whenequipmentissoldforanote
receivable,moneyisrealizedsinceanotequalifies
asaclaimtocash.Answers(a)and(d)relateto
costallocation.Answer(c)isincorrectbecause
accountsreceivablerepresentsaclaimtocash.
Realizationoccursatthetimeofsaleratherthan
whencashiscollected.
12. (d)Alosscontingencyisaccruedbyachargetoexpenseifit
isreasonablyestimableanditisprobablethataliability
hasbeenincurredasofthebalancesheetdate.Thecauseof
theliabilitymusthaveoccurredonorbeforethedateof
thefinancialstatementsiftheliabilityistobeaccrued,
becausetheintentionistorecognizethelossinthesame
periodthattheunderlyingcausetookplace.Therefore,some
authoritieswouldsaythatmatchingistheunderlying
conceptsupportingtheimmediaterecognitionofacontin
gentloss.Alargernumber,however,wouldmentioncon
servatismasthemorepervasiveunderlyingconceptsup
portingtheimmediaterecognitionoftheselosses.
ofanentitysmajororprimaryoperations.Twoessential
characteristicsofrevenuesarethatrevenues(1)arisefroma
companysprimaryearningsactivitiesand(2)arerecurring
orcontinuinginnature.Therefore,answer(d)iscorrect
becauseitmeetstheabovecriteria.Answers(b)and(c)are
incorrectbecausetheyresultfromincidentaltransactions.
Answer(a)isincorrectbecauseadecreaseofanassetisnot
arevenue.
16. (d)PerSFAC6,thecommonqualitysharedby
allassetsisservicepotentialorfuture
economicbenefit.PerSFAC6,assets
commonlyhaveotherdistinguishingfeatures,
suchasbeinglegallyenforceable,tangibleorac
quiredatacost.Thesefeatures,however,arenot
essentialcharacteristicsofassets.
13. (a)Conservatismmeansthatwhenindoubt,ac
countantsshouldchoosetheprocedurethatwillbe
leastlikelytooverstateassetsandincome.This
conceptunderliestheGAAPpertainingto
17. (d)PerSFAC5,fivedifferentattributesareusedtomeasure
recordinggaincontingencies.Inanefforttonot
assetsandliabilitiesinpresentpractice:historicalcost,
overstateassetsorincome,gaincontingenciesare
current(replacement)cost,currentmarketvalue,net
notrecordeduntiltheyarenolonger
realizablevalue,andpresentvalueoffuturecashflows.
contingencies,andaredisclosedonlywhen
Threeofthese(historicalcost,replacementcost,andnet
probabilitiesarehighthatagaincontingencywill
realizablevalue)areusedinmeasuringinventoryatlowerof
becomereality.
costormarket.Presentvalueoffuturecashflowsisnotused
tomeasureinventory.
14. (c)PerSFAC6,themajordifferencebetween
financialandphysicalcapitalmaintenanceis
CashFlowInformationandPresentValue(SFAC7)
relatedtotheeffectsofpricechangesonassets
18. (c)Themostrelevantmeasureofaliability
heldandliabilitiesowedduringaperiod.The
financialcapitalconceptisappliedincurrent
alwaysreflectsthecreditstandingoftheentity
GAAP.Underthisconcept,theeffectsoftheprice
obligatedtopay,accordingtoSFAC7.Those
changesdescribedaboveareconsideredholding
whoholdtheentitysobligationsasassets
gainsandlosses,andareincludedincomputing
incorporatetheentityscreditstandinginde
returnoncapital.Comprehensiveincome,which
terminingthepricestheyarewillingtopay.
isdescribedinSFAC5,isthechangeinequityof
19. (d)SFAC7providesaframeworkforusingfuture
abusinessenterpriseduringaperiodfrom
cashflowsasthebasisforaccountingmeasurements
transactionsandothereventsandcircumstances
atinitialrecognitionorfreshstartmeasurementsand
fromnonownersources.Itisalsoameasureof
fortheinter
returnonfinancialcapital.Theconceptof
estmethodofamortization.FASBlimitedSFAC7
physicalcapitalmaintenanceseekstomeasurethe
tomeasurementissues(howtomeasure)andchosenotto
effectsofpricechangesthatarenotcurrently
capturedunderGAAP(e.g.,replacementcostsof
addressrecognitionquestions(whentomeasure).SFAC
nonmonetaryassets).Underthisconcept,holding
7introducestheexpectedcashflowapproach,whichdiffers
gainsandlossesareconsideredcapital
fromthetraditionalapproachbyfocusingonexplicitas
maintenanceadjustmentswhichwouldbe
sumptionsabouttherangeofpossibleestimatedcashflows
includeddirectlyinequityandexcludedfrom
andtheirrespectiveprobabilities.
returnoncapital.
20. (d)Theexpectedcashflowapproachusesallex
15. (d)PerSFAC6,revenuesareinflowsofassetsor
pectationsaboutpossiblecashflowsindeveloping
settlementsofliabilities,orboth,duringaperiod
ameasurement,ratherthanjustthesinglemost
asaresult
likelycashflow.Byincorporatingarangeof
possibleoutcomes(withtheirrespectivetiming
differences),theexpectedcashflowapproach
accommodatestheuseofpresentvaluetechniques
whenthetimingofcashflowsisuncertain.Thus,
theexpectedcashflowislikelytoprovidea
betterestimateoffairvaluethantheminimum,
mostlikely,ormaximumtakenalone.According
toSFAC7,expectedpresentvaluereferstothe
sumofprobabilityweightedpresentvaluesina
rangeofestimatedcashflows,alldiscounted
usingthesameinterestrateconvention.
21. (b) The computation of expected present value
usingasingleinterestrateisasfollows:
PVof$200,000inoneyearat5%
Probability
$190,476
20%
$38,095
PVof$200,000intwoyearsat5%
Probability
$181,406
50%
90,703
PVof$200,000inthreeyearsat5%
Probability
$172,768
30%
51,830
$180,628
256
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
AccordingtoSFAC7,expectedpresent
valuereferstothesumofprobability
weightedpresentvaluesinarangeof
estimatedcashflows,alldiscountedusing
thesameinterestrateconvention.
22. (c)Likedepreciationand
amortizationconventions,interest
methodsaregroundedinnotionsof
historicalcost,notcurrentcost.
Interpretations,AICPAStatements
ofPosition,AICPAAuditand
AccountingGuides,andPractice
Bulletins.TheFASBAccounting
StandardsCodificationdoesnot
includetheAICPAStatementsof
AuditingStandards.Theauditing
standardsareincludedinthe
ProfessionalStandardsissuedbythe
AICPA.
A.2.IncomeDetermination
23. (a)AccordingtoSFAC7,the
26. (b)Generally,salesrevenueisrecognizedat
objectiveofusingpresentvalueinan
thedateofdelivery,becausethatgenerallyis
accountingmeasurementisto
thetimeatwhichasalehasoccurred.Atthat
capture,totheextentpossible,the
pointthetwocriteriaforrevenuerecognition
economicdifferencebetweensetsof
weremet;therevenueis(1)realizedor
futurecashflows.Theobjectiveof
realizableand(2)itisearned(SFAC6).
presentvalue,whenusedin
Therefore,theamountofsalesrevenue
accountingmeasurementsatinitial
recognizedin2010is$150,000(50,000$3=
recognitionandfreshstart
$150,000).
measurements,istoestimatefair
27. (c)Incomegenerallyaccruesonlyatthetime
value.Stateddifferently,present
ofsale,andgainsmaynotbeanticipatedby
valueshouldattempttocapturethe
reflectingassetsattheircurrentsalesprices.
elementsthattakentogetherwould
Exceptiontothisgeneralruleisgranted,
compriseamarketprice,ifone
however,foragriculturalproductsthatare
existed,thatisfairvalue.Valuein
homogenousandhaveanimmediate
useandentityspecificmeasurements
marketabilityatquotedpricessuchasthe
attempttocapturethevalueofan
cottoninthisproblem(ASC.905330301).
assetorliabilityinthecontextofa
Whentheseinventoriesarestatedatsales
particularentity.Anentityspecific
prices,theyshouldbereducedbyexpenditures
measurementsubstitutestheentitys
tobeincurredindisposal.AmarFarmsshould,
assumptionsforthosethat
therefore,recognizerevenueontheentire
marketplaceparticipantswould
make.
24. (c)TheCodificationprovides
guidanceonthedeterminationof
gainorlossondisposalofa
componentofabusiness.According
tothisguidance,suchdetermination
shouldbebasedonestimatesofthe
netrealizablevalueofthe
component.SinceBrooksCo.plans
todiscontinueitsentireoperations,
theappropriatemeasurementbasis
foritsequipmentisnetrealizable
value.Historicalcostandcurrent
reproductionandreplacementcosts
arenotappropriatemeasurement
basesforassetsonceanentityhas
decidedtodiscontinueitsoperations
becausetheseamountsdonotreflect
theentitysprobablefuturebenefit,
whichisacharacteristicofassetsper
SFAC6.
25. (d)TheFASBAccountingStandards
Codificationincludesallprevious
levelADGAAP.TheCodification
includestheauthoritativeliterature
oftheFinancialAccounting
StandardsBoard,theEmerging
IssuesTaskForceAbstracts,
AccountingPrinciplesBoard
Opinions,AccountingResearch
Bulletins,Accounting
300,000poundcropin2010attheguaranteed
(andprevailing)marketpriceof$.70per
pound.Thisamountsto$210,000(300,000
pounds$.70perpound=$210,000).Note
thattheadditional$.02perpoundforthe
cottonsoldin2011wouldberecognizedin
2011,sinceitssellingpriceexceededthe
current(2010)marketprice.
28.(a)Revenuefromthesaleofaproduct
mayberecognizedatthetimeofsaleonly
ifallofthefollowingconditionsaremet:
1.
6. Theamountoffuturereturnscanbe
reasonablyestimated.
Becausethebuyer,Zee,hastherightto
returnthemachinetotheseller,Lin,
condition(2)abovehasnotbeenmet.
Therefore,therecognitionofsalesrevenue
andcostofsalesisnotallowableforthis
transaction.
A.3.AccrualsandDeferrals
29. (b)Underaccrualaccounting,events
thatchangeanentitysfinancial
positionarerecordedintheperiodin
whichtheeventsoccur.Thismeans
revenuesarerecognizedwhenearned
ratherthanwhencashisreceived,
andexpensesarerecognizedwhen
incurredratherthanwhencashis
paid.Therefore,whentheroyalties
arepaid,Wandshoulddebitanasset
account(prepaidroyalties)rather
thananexpenseaccount.The
royaltiespaidshouldbereportedas
expenseintheperiodincurred(by
debitingroyaltyexpenseandcredit
ingprepaidroyalties).
30. (c)Thebalanceintheadvertising
expenseaccounton12/31/10before
adjustmentis$146,000.Sincethe
salespromotionalcampaignistobe
conductedinJanuary,anyassociated
costsareanexpenseof2011.Thus,
the$15,000costofprintingcatalogs
shouldberemovedfromtheadver
tisingexpenseaccountandrecorded
asaprepaidexpenseasof12/31/10.
Inaddition,advertisingexpense
mustbeincreasedbythe$9,000
costofDecembersradioadvertise
ments,whichareanexpenseof2010
eventhoughtheywerenotbilledto
Clarkorpaiduntil2011.The$9,000
mustbeaccruedasanexpenseanda
liabilityat12/31/10.Therefore,2010
advertisingexpenseshouldtotal
$140,000($146,000$15,000+
$9,000).
31. (b) The opening balance in prepaid
expenses
($1,500)resultsfromaoneyearinsurance
premiumpaidon7/1/09.Sincethispolicy
wouldhaveexpiredby6/30/10,nopartofthe
$1,500isincludedin12/31/10prepaid
expenses.Theinsurancepremiumpaidon
7/1/10($3,200)wouldbepartiallyexpired
(6/12)by12/31/10.Theremainder(6/12
$3,200=$1,600)wouldbeaprepaidexpense
atyearend.Theentireadvancerentalpayment
($2,000)isaprepaidexpenseat12/31/10
becauseitappliesto2011.Therefore,total
12/31/10prepaidexpensesare$3,600.
Prepaidinsurance($3,2006/12)
Prepaidrent
Totalprepaidexpenses
$1,600
2,000
$3,600
revenuebecausethisamount
pertainstorevenuesearnedforJuly
32. (b)ApparentlyRororecordspolicy
throughDecemberof2009and
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
257
wouldhavebeenaccruedasrevenue
paymentsaschargestoinsurance
on12/31/09.On9/15/10,Wren
expenseandrecordsprepaid
received$17,000inroyaltiesforthe
insuranceattheendofthequarter
firsthalfof2010.Royaltiesforthe
throughanadjustingentry.The
secondhalfof2010willnotbe
unadjustedtrialbalanceamountsat
receiveduntil3/15/11.However,the
3/31/10mustrepresentthefinaltwo
royaltypaymenttobereceivedfor
monthsoftheoldpolicy($300of
thesecondsixmonths(15%
prepaidinsurance)andthecostof
$60,000=$9,000)hasbeenearned
thenewpolicy($7,200ofinsurance
andshouldbeaccruedat12/31/10.
expense).Anadjustingentrymust
Therefore,2010royaltyrevenueis
bepreparedtoreflectthecorrect
$26,000($17,000+$9,000).
3/31/10balances.Sincethenew
policyhasbeeninforceonemonth
36. (d)TheagreementstatesthatSuperisto
(3/1through3/31),thirtyfive
receiveroyaltiesof20%ofrevenues
monthsremainunexpired.
associatedwiththecomicstrip.Since
Therefore,thebalanceinprepaid
Fantasys2011revenuesfromthestripwere
insuranceshouldbe$7,000($7,200
$1,500,000,Supersroyaltyrevenueis
35/36).Insuranceexpenseshould
$300,000($1,500,00020%).Theother
includethecostofthelasttwo
informationintheproblemaboutthe
monthsoftheoldpolicyandthefirst
receivableandcashpaymentsisnotneededto
monthofthenewpolicy[$300+
computerevenues.Supers2011summary
($7,2001/36)=$500].Roros
entrieswouldbe
adjustingentrywouldtransfer
$6,700frominsuranceexpenseto
prepaidinsurancetoresultinthe
correctbalances.
33. (c)At12/31/10,theliabilityaccount
unearnedsubscriptionrevenue
shouldhaveabalancewhichreflects
allunexpiredsubscriptions.Ofthe
2009sales,$125,000expires
during2011andwouldstillbea
liabilityat12/31/10.Ofthe2010
sales,$340,000($200,000+
$140,000)expiresduring2011and
2012,andthereforeisaliabilityat
12/31/10.Therefore,thetotal
liabilityis$465,000($125,000+
$340,000).Thisamountwouldhave
toberemovedfromthesales
accountandrecordedasaliabilityin
a12/31/10adjustingentry.
34. (d)Regalsunredeemedgift
certificatesat12/31/09are$75,000.
During2010,thesecertificatesare
eitherredeemed($25,000)orexpire
by12/31/10($75,000$25,000=
$50,000).Therefore,noneofthe
$75,000affectsthe12/31/10
unearnedrevenueamount.During
2010,additionalcertificatestotaling
$250,000weresold.Ofthisamount,
$225,000isexpectedtoberedeemed
inthefuture[$250,000
(10%$250,000)].Since$175,000of
2010certificateswereredeemedin2010,
12/31/10unearnedrevenueis$50,000
($225,000$175,000).
35. (a)Therequirementistocalculate
Wrensroyaltyrevenuefor2010.
The3/15/10royaltyreceipt
($12,000)wouldnotaffect2010
Cash
Royaltiesrec.
Royaltyrevenue
Royaltiesrec.
Royaltyrevenue
200,000
175,000
75,000
125,000
($200,000$75,000)
175,000
($300,000$125,000)
37.(c)Royaltyrevenuesshouldbe
recognizedwhenearned,regardlessof
whenthecashiscollected.Royalty
revenueearnedfrom12/1/09to5/31/10is
$80,000($400,00020%).Ofthisamount,
$10,000($50,00020%)wasearnedin
Decemberof2009,sotheportionearnedin
thefirstfivemonthsof2010is$70,000
($80,000$10,000).Royaltyrevenueearned
from6/1/10to11/30/10is$65,000($325,000
20%).Theamountearnedfrom12/1/10to
12/31/10,whichwouldbeaccruedat12/31,is
$14,000($70,00020%).Therefore,2010
royaltyrevenueis$149,000.
1/1/105/31/10
6/1/1011/30/10
12/1/1012/31/10
38.(b)Therequirementistocalculatethe
amountofroyaltyincometoberecognizedin
2010.Cashcollectedforroyaltiestotaled
$200,000in2010.However,thisamount
mustbeadjustedforchangesintherelated
accounts,asfollows:
2010cashreceived
Royaltiesreceivable12/31/09
Royaltiesreceivable12/31/10
Unearnedroyalties12/31/09
Unearnedroyalties12/31/10
Royaltyincome
Thebeginningreceivablebalance($90,000)is
subtractedbecausethatportionofthecash
collectedwasrecognizedasrevenuelastyear.
Theendingreceivablebalance($85,000)is
addedbecausethatamountis2010revenue,
eventhoughithasnotyetbeencollected.The
beginningbalanceofunearnedroyalties
($60,000)isaddedbecausethatamountis
assumedtobeearnedduringtheyear.Finally,
theendingbalanceofunearnedroyalties
($40,000)issubtractedsincethisamountwas
collected,butnotearnedasrevenue,by
12/31/10.
39.(b)Therequirementistodeterminethe
amountofroyaltyexpensetoberecognized
in2010.Cashpaidforroyaltiestotaled
$300,000in2010.However,thisamount
mustbeadjustedforchangesintherelated
accounts,asfollows:
$70,000
65,000
14,000
$149,000
2010cashpaid
Royaltiespayable12/31/09
Royaltiespayable12/31/10
Prepaidroyalties12/31/09
Prepaidroyalties12/31/10
$300,000
(80,000)
75,000
55,000
(45,000)
$305,000
Thebeginningpayablebalance($80,000)is
subtractedbecausethatportionofthecash
paidwasrecognizedasexpenseduringthe
previousyear.Theendingpayablebalance
($75,000)isaddedbecausethatamounthas
beenaccruedas2010expense,eventhoughit
hasnotyetbeenpaid.Thebeginningbalance
ofprepaidroyalties($55,000)isadded
$200,000
becausethatamountisassumedtohave
(90,000)
expiredduringtheyear.Finally,theending
balanceofprepaidroyalties($45,000)is
(40,000
subtractedsincethisamountwaspaid,butnot
$215,000
incurredasanexpense,by12/31/10.
40.(b)Whentheinsurancepolicywas
initiallypurchased,theentirebalancewas
debitedtoaprepaidassetaccount(i.e.,
prepaidinsurance).Theadjustingentryat
December31,2010,torecognizethe
expirationofoneyearofthepolicywouldbe
Insuranceexpense
Prepaidinsurance
pymt.)
(1/3oforiginalpymt.)
(1/3oforiginal
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
258
Service Revenue
Aftertheadjustingentry,theprepaidasset
accountwouldcontain2/3oftheoriginal
payment.Iftheoriginalpaymenthadinstead
beendebitedtoanexpenseaccount(i.e.,
insuranceexpense),thentheadjustingentry
atDecember31,2010wouldbe
Prepaidinsurance
Insuranceexpense
Acct . Receivable
1/1/ 10
40,000
220,000
200,000
220,000
5,000
215,000
12/ 31/ 10
received
60,000
Unearned Revenue
(2/3oforiginalpymt.)
(2/3oforiginal
pymt.)
41. (b)Currentassetsareidentifiedas
resourcesthatarereasonably
expectedtoberealizedincashor
soldorconsumedduringthe
normaloperatingcycleofthe
business.Theseresourcesinclude
prepaidexpensessuchasroyalties.
SincethebalanceremaininginSip
Co.sroyaltyprepayment(the
paymentrelatingto2011royalties)
willbeconsumedwithinthenext
year,itshouldbereportedasa
currentasset.Additionally,the
paymentrelatingto2010shouldbe
reportedasanexpense.
42. (b)Atthetimethegiftcertificates
were issued, the following entry
was made, reflecting the stores
future obligation to honor the
certificates:
xx
Deferredrevenue
xx
Uponredemptionofthecertificates,the
obligationrecordedinthedeferredrevenue
accountbecomessatisfiedandtherevenueis
earned.Similarly,asthecertificatesexpire,
thestoreisnolongerunderanyobligationto
honorthecertificatesandthedeferred
revenueshouldbetakenintoincome.Inboth
instances,thedeferredrevenueaccountmust
bereduced(debited)toreflecttheearningof
revenue.Thisisdonethroughthefollowing
entry:
Deferredrevenue
Revenue
1/1/ 10
5,000
Thisalternateapproachwouldalsoresultin
1/3oftheoriginalpaymentbeingexpensedin
2010and2/3oftheoriginalpaymentbeing
carriedforwardasaprepaidasset.Thus,
answer(b)iscorrect.Answer(a)isincorrect
becausethepremiumpaidwasforathreeyear
policy,2/3ofwhichhadnotyetexpiredand
wouldthereforebecarriedforwardinthe
prepaidassetaccount.Answer(c)isincorrect
because1/3oftheoriginalpaymentwas
alreadyexpensed.Answer(d)isincorrect
becausetheamountwouldbethesameasit
wouldhavebeeniftheoriginalpaymenthad
beendebitedinitiallytoanexpenseaccount
(asexplainedforanswer(b)above).
Cash
Cash
xx
xx
5,000
12/ 31/ 10
45. (d)Todeterminecashbasisrevenue,the
solutionsapproach is to prepare a Taccount
foraccountsreceivable.
12/31/09
Sales
12/31/10
AccountsReceivable
1,000,000
4,600,000
20,000 Writeoffs
?
Collections
1,300,000
Themissingamountforcashcollectionsis
$4,280,000.Anotherapproachistousethe
followingformula:
Sales +Decrease(increase)inAR Writeoffs=Collections
$4,600,000
$300,000
$20,000=$4,280,000
Theincreaseinreceivables($300,000)means
thatcashcollectedduringtheperiodwasless
thansalesduringtheperiodandthereforeis
deductedfromsalesrevenue.Thewriteoffs
($20,000)representrecognizedsalesthatwill
neverbecollectedincashandthereforemust
alsobedeductedtocomputecollections.
46.(d)Todeterminerentalrevenue,the
solutionsapproachistoprepareaTaccount
forrentsreceivableandrentrevenues.
RentReceivable
11/30/09800,000
b
1,090,000
Bal1,060,000
800,000
RentRevenues
a
2,210,000
b
1,090,000
800,000
30,000
1,060,000+30,000
Toremove2009revenuefromthe$2,210,000ofcash
collectedandrelieverentreceivableofcollections
from2009receivables.
Torecognizeunrecordedrentearnedincludingwriteoffs.
Torecognizewriteoffs.Debitwouldbetothe
allowanceaccount.
Bal2,500,000
43.(a)Therevenuesfromservicecontracts
shouldberecognizedonaproratabasisoverthe
termofthecontract.Thistreatmentallocatesthe
contractrevenuestotheperiod(s)inwhichthey
areearned.Sincethesaleofaservicecontract
doesnotculminateinthecompletionofthe
earningsprocess(i.e.,doesnotrepresentthe
sellersperformanceofthecontract),payments
receivedforsuchacontractshouldberecorded
initiallyinadeferredrevenueaccount.
A.4.CashtoAccrual
44.(c)Thefollowingformulaisusedto
adjustservicerevenuefromthecashbasisto
theaccrualbasis:
Cashfees
collected
End.
AR
Beg.
AR
Beg.
+unearned
fees
End.
unearned=
fees
$200,000+$60,000$40,000+0$5,000
=$215,000
Asanalternative,Taccountscanbeused.
47.(d)Underthecashbasismethodof
accounting,revenueisrecognizedasitis
collected.Cashsalesafterreturnsand
allowancestotaled$76,000($80,000
$4,000).Netcreditsalesfor2010were
$114,000($120,000creditsales$6,000
discounts).Asmadeevidentbythefollowing
Taccount,cashcollectionsfromcreditsales
mustequal$124,000($40,000+$114,000
$30,000),since$10,000inexcessofcurrent
creditsaleswasreceivedandreduced
AccountsReceivablebythisamount.
Bal.1/1
Netcreditsales
Bal.12/31
AccountsReceivable
40,000
114,000
?
30,000
Asummaryjournalentrywouldbe
Collections
Cash
Salesdiscounts
Accountsreceivable
124,000
6,000
March31).Therefore,cashbasisincomeis
$5,000.Drawingsare$1,000.Therefore,
130,000
endingcapitalis$6,000($2,000+$0+$5,000
Totalcashbasisrevenuefor2010is
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
259
$1,000).
$200,000asshownbelow.
Cashsales($80,000$4,000)
Collectionsofcreditsales[($40,000+$120,000
$30,000)$6,000]
Totalcashreceived
51.(d)Therequirementofthisquestionisto
determineifadecreaseinaccountsreceivable
and/oradecreaseinaccruedexpenses
wouldresultincashbasisincomebeing
lowerthanaccrualbasisincome.
48. (a)Costofgoodssoldiscomputedas
follows:
Adecreaseintheaccountsreceivablebalance
wouldgenerallymeanthatcashwascollected.
Inaccordancewiththecashbasisofaccounting
whencashisreceiveditisrecordedasrevenue
(Dr.Cash,Cr.Revenue),whereasundertheac
crualbasistherevenuewouldhavebeen
recordedwhenthe
Beg.inv.+NetpurchasesEnd.inv.=
CGS
Netpurchasesmustbecomputedfromthe
informationgivenusingaTaccountora
formula.
AP
Payments
490,000
50,000 12/31/09
?
Purchases
75,000 12/31/10
Themissingamountforpurchasesis
$515,000.Anotherapproachistousethe
followingformula:
Payments
$490,000
+ EndingAP BeginningAP=
+ $75,000 $50,000=
Purchases
$515,000
Thisamountcanbeusedtodeterminecostof
goodssold
Beg.inventory
+Netpurchases
Costofgoodsavailable
End.inventory
Costofgoodssold
$290,000
515,000
805,000
260,000
$545,000
49. (d)Cashbasisincomeof$60,000must
be adjustedfor changes in accounts
receivableandaccountspayabletocompute
accrualincome
Cashbasisincome
12/31/09AR
12/31/10AR
12/31/09AP
12/31/10AP
Accrualincome
ThebeginningAR($20,000)issubtracted
becausealthoughthisamountwascollected
in2010,itisproperlyaccruedas2009
revenue.TheendingARisaddedbecause
althoughnotcollectedin2010,itshouldbe
accruedas2010revenue.ThebeginningAP
isaddedbecausealthoughthisamountwas
paidin2010,itisproperlyaccruedas2009
expense.TheendingAPissubtracted
becausealthoughnotpaidin2010,itshould
beaccruedas2010expense.
50.(c)TheendingbalanceinToryscapital
accountoneithertheaccrualorcashbasisis
computedasfollows:
Beginning
capital
+ Investments+IncomeDrawings=
Torysbeginningcapitalishisinitialcash
investmentof$2,000.Nootherinvestments
weremade.Underthecashbasismethodof
accounting,incomeistheexcessofcash
revenues($5,000)overcashexpenses($0,
sincetheexpenseswerenotpaiduntilafter
$60,000
(20,000)
(15,000
$
receivablewasrecorded(Dr.AR,Cr.
Revenue).Thus,adecreasedaccounts
receivablebalancewouldresultinincreased
revenue/income.Therefore,theanswerforthis
accountisNo.
Adecreaseintheaccruedexpensesaccount
wouldgenerallymeancashwaspaidonsome
expenses.Underthecashbasis,whenthecashis
paidtheexpenseisrecorded(Dr.
Expense,Cr.Cash),whereasunderthe
accrualbasistheexpensewouldhavebeen
recordedwhentheaccruedexpensewas
recorded(Dr.Expense,Cr.Accrued
Expense).Thus,adecreasedaccrued
expensesaccountwouldresultinincreased
expenses/lowerincomeforthecashbasis.
Thus,theanswerforthisaccountisYes.
52. (b)Whenacompanyoperatesonthe
accrualbasis,suppliesare
inventoriedandexpensedastheyare
used.Underthecashmethod,
however,suppliesareexpensedas
theyarepaidfor.ThereforeifWhite
Co.experiencesanincreasein
suppliesinventoryduringtheyear,
thisincreasemustbedeductedfrom
accrualincometogettothecash
basis,becausethecostofthe
supplieswouldbeexpensedatthe
timeofpurchase.
Officesalariespayableworkstheopposite
way.Undertheaccrualmethod,aliability
wouldhavebeenestablishedresultingin
additionalexpenseovertheamountofcash
paidtoemployees.Underthecashmethod,no
liabilityisaccruedandtheunpaidsalariesare
notexpensed.Therefore,theincreasemustbe
addedtotheaccrualbasisnetincome.
53. (c)Priorto2010,DroitCo.usedthe
cashbasisofaccounting.
Accordingly,Droitwouldhave
expensedallpurchasesofsuppliesas
incurred.Incontrast,undertheac
crualbasisofaccounting,thecostof
unusedsuppliesateachyearend
wouldhavebeencarriedasanasset
and,therefore,excludedfromthe
currentyearssuppliesexpense.In
2010,theyearDroitadoptedthe
accrualbasisofaccounting,Droit
wouldhaveinventoriedunused
suppliesatDecember31and
excludedthosecostsfrom2010net
income.Sincethecostof2010s
beginningbalanceofsupplieswas
expensedduring2009,eventhough
thesupplieswerenotuseduntil
2010,Droitsinabilitytodetermine
thebeginningsuppliesinventory
wouldresultinanunderstatementof
suppliesexpenseandoverstatement
of2010netincome.However,since
Droitproperlyinventoriedsupplies
atDecember31,2010,its
cumulative(inceptiontodate)
suppliesexpensewouldbeproperly
stated.Therefore,Droitsinabilityto
determine2010sbeginningsupplies
expensewouldhavenoimpacton
DroitsDecember31,2010retained
earnings.
A.5.InstallmentSales
54.(b)Undertheinstallmentmethod,gross
profitisdeferredatthetimeofsaleandis
recognizedbyapplyingthegrossprofitrateto
subsequentcashcollections.Atthetimeof
sale,grossprofitof$250,000isdeferred
($500,000installmentsalesless$250,000
costofinstallmentsales).Thegrossprofitrate
is50%($250,000$500,000).Since2010
collectionsoninstallmentsaleswere
$100,000,grossprofitof$50,000(50%
$100,000)isrecognizedin2010.Thiswould
decreasethedeferredgrossprofitaccounttoa
12/31/10balanceof$200,000($250,000
$50,000).Notethatregularsales,costof
regularsales,andgeneralandadministrative
expensesdonotaffectthedeferredgross
profitaccount.
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
260
55.(d)Undertheinstallmentsalesmethod,
grossprofitisdeferredtofutureperiodsand
recognizedproportionatelytocollectionofthe
receivables.Therefore,ateachyearend,
deferredgrossprofitcanbecomputedby
multiplyingthegrossprofitpercentagebythe
accountsreceivablebalance,asindicated
below.
recognizedis$250,000($100,000
grossprofit+$150,000interest
revenue).
59. (a)Themachinesaleisaccounted
forusingtheinstallmentmethod,
wheregrossprofitisdeferredand
recognizedinproportiontocash
collected.Initially,theentire
$270,000gainisdeferred.In2010,
$150,000ofthesalespricewas
2010
collected,andthegrossprofit
Sales
$900,000
percentageis30%($270,000
2009 Collections
$900,000),sogrossprofitrecognized
2010 Collections
(300,000)
2009 Writeoffs
was$45,000(30%$150,000).In
2010 Writeoffs
(50,000)
2011,$250,000ofthesalesprice
12/31/10AR
$550,000
$100,000
wascollected,sogrossprofit
Grossprofit%
40%
recognizedwas$75,000(30%
12/31/10DeferredGP
$220,000
$
$250,000).Therefore,at12/31/11,
Thus,totaldeferredgrossprofitat
deferredgrossprofitis$150,000
12/31/10is$250,000($220,000+
($270,000$45,000$75,000).As
$30,000).
ashortcut,youcancomputethe
12/31/11notereceivablebalance
56.(d)Undertheinstallmentsalesmethod,
($750,000$250,000=$500,000),
grossprofitisdeferredtofutureperiodsandis
andmultiplybythe30%grossprofit
recognizedproportionatelyascashis
percentage(30%$500,000=
collected.Todeterminecashcollectionsinthis
$150,000).
case,firstcomputethe2011installmentsales
bydividingdeferredgrossprofitbythegross
profitpercentage($560,000 40%=
$1,400,000).Then,the12/31/11installment
accountsreceivableissubtractedtodetermine
cashcollections($1,400,000$800,000=
$600,000).Realizedgrossprofitisthen
computedbymultiplyingcashcollectionsby
thegrossprofitpercentage($600,00040%=
$240,000).
57.(c)Whenusingtheinstallmentmethod,
grossprofitrealizediscomputedasindicated
below.
Cashcollections
realized
GP%
GP
Thisequationcanberearrangedasfollows:
GPrealized
GP%
Cash
collections
Therefore,cashcollectedtodateon2010
salesis$800,000[($150,000+$90,000)
30%],andon2011salesis$500,000
($200,00040%).Installmentaccounts
receivableat12/31/11iscomputedby
subtractingcashcollectionsfromtheoriginal
salesamount.
InstallmentAR2010($1,000,000$800,000)
InstallmentAR2011($2,000,000$500,000)
Total12/31/11installmentAR
58. (a)Theequipmentsaleisaccounted
forusingtheinstallmentmethod.
Thegrossprofitpercentageonthe
saleis331/3%($600,000profit
$1,800,000sellingprice).Since
$300,000ofthesalespriceis
collectedin2011,grossprofitof
$100,000isrecognized(331/3%
$300,000).Thetotalrevenue
Notethattheinterestcollected($75,000)
doesnotaffectthecomputationbecauseitis
notacollectionofsalesprice.
60. (c)Theprofitonasaleintheordinarycourse
ofbusinessisconsideredtoberealizedatthe
timeofsaleunlessitisuncertainwhetherthe
salepricewillbecollected.TheBoard
concludedthatuseoftheinstallmentmethod
ofaccountingisnotacceptableunlessthis
uncertaintyexists.Answers(a),(b),and(d)
areincorrectbecausetheydonotinvolvethe
elementofuncertaintyregardingthe
collectibilityofthesaleprice.
61. (c)Accordingtotheinstallment
methodofaccounting,grossprofiton
aninstallmentsaleisrecognizedin
incomeinproportiontothecash
collection.Thecashcollectedfroma
givenyearssalesismultipliedbythat
yearsgrossprofitpercentageto
computetheamountofgrossprofit
toberecognized.Answer(a)describesthe
pointofsalerecognitionbasis,whileanswer
(d)describesthecostrecoverymethod.
Answer(b)doesnotdescribeany
recognitionbasiscurrentlyused.
62. (c)Theinstallmentmethodofaccountingisused
whenthereisahighdegreeofuncertainty
regardingthecollectibilityofthesaleprice.
Underthismethod,salesrevenuesandthe
relatedcostofgoodssoldarerecognizedinthe
periodofthesale.However,thegrossprofitis
deferredtotheperiodsinwhichcashiscollected.
Incomerecognizedintheperiodofcollectionis
generallycomputedbymultiplyingthecash
collectedbythegrossmarginpercentage.Thein
stallmentmethodisbasedupondeferralofthe
grossprofit,notthenetoperatingprofit.The
installmentmethodisgenerallyonlyapplicable
whenthereportingcompanyisunableto
estimatetheamountofuncollectibleaccounts.
63. (d)Undertheinstallmentmethod
(caseI)revenue(grossprofit)is
recognizedafterthesale,in
proportiontocashcollected.Under
thecostrecoverymethod(caseII),
revenue(grossprofit)isagain
recognizedafterthesale,when
cumulativereceiptsexceedthecost
oftheassetsold.Therefore,revenue
isnotrecognizedpriortothesaleof
merchandiseineithercaseIorcase
II.
A.6.CostRecoveryMethod
64. (d)Underthecostrecoverymethod
noprofitofanytypeisrecognized
untilthecumulativereceipts
(principalandinterest)exceedthe
costoftheassetsold.Thismeans
thattheentiregrossprofit
($3,000,000$2,000,000=
$1,000,000)andthe2011interest
received($270,000)willbedeferred
untilcashcollectionsexceed
$2,000,000.Therefore,noincomeis
recognizedin2011.
65. (d)Theinstallmentmethodisused
whencollectionofthesellingprice
isnotreasonablyassured.However,
whentheuncertaintyofcollectionis
sogreatthateventheuseofthe
installmentmethodisprecluded,
thenthecostrecoverymethodmay
beused.Havingnoreasonablebasis
forestimatingcollectibilitywould
provideagreatenoughuncertainty
tousethecostrecoverymethod.Itis
importanttonotethatanytimethe
installmentmethodisused,some
riskof100%collectionexists,but
theriskmustbeextremebeforethe
costrecoverymethodisemployed.
66. (a)Installmentmethodsof
recognizingrevenueareappropriate
onlywhencollectionofthesale
priceisnotreasonablyassured.
Underthecostrecoverymethod,
gross
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
atitsownrisk.
profitisdeferredandrecognizedonlywhen
thecumulativereceiptsexceedthecostof
theassetsold.
A.7.FranchiseAgreements
67.(d)Franchisefeerevenueisrecognized
whenallmaterialserviceshavebeen
substantiallyperformedbythefranchiser.
Substantialperformancemeansthefranchiser
hasperformedsubstantiallyallofrequired
initialservicesandhasnoremaining
obligationtorefundanycashreceived.The
$60,000nonrefundabledownpaymentapplies
totheinitialservicesalreadyperformedby
2.
Rice.Therefore,the$60,000maybe
recognizedasrevenuein2010.Thethree
remaining$30,000installmentsrelateto
substantialfutureservicestobeperformedby
Rice.Thepresentvalueofthesepayments
($72,000)isrecordedasunearnedfranchise
feesandrecognizedasrevenueonce
substantialperformanceofthefutureservices
hasoccurred.
Cash
Notesreceivable
Discountonnotesreceivable
Franchiserevenue
Unearnedfranchisefees
60,000
90,000
68.(c)Initialfranchisefeesarenotrecognized
asrevenueuntilthefranchisormakes
substantialperformanceoftherequired
services,andcollectionisreasonablyassured.
SincePotterPiehasnotyetperformedthe
requiredservices,theinitialfranchisefee(21
$30,000=$630,000)isreportedas
unearnedfranchisefeesat12/31/10.The
estimateduncollectibleamount($20,000)
normallywouldberecordedasadebittobad
debtexpenseandacredittoallowancefor
uncollectibleaccounts.However,since
norevenuehasyetbeenrecognized,itis
inappropriatetorecordbaddebtexpense.
Instead,unearnedfranchisefeesisdebited,
becauseanunearnedrevenueshouldnotbe
recordedwhen,ineffect,norelatedassethas
beenreceived.Therefore,thenetunearned
franchisefeesis$610,000($630,000
$20,000).
A.8.RealEstateTransactions
69.(d)ItemsIandIIdonottransfertherisks
andrewardsofownershiptothebuyersince
bothscenariosentitlethebuyertoareturnof
his/herinitialinvestment.Thus,therisksof
ownershipstillremainwiththeseller.The
economicsubstanceofsucharrangementsis
thatoffinancing,leasing,orprofitsharing
transactions.ItemIIItransferstherisksand
rewardsofownershipsincethesellerwillbe
reimbursedforcostplusa5%profitonthe
supportprovided.Therefore,thesellerisnot
requiredtosupportoperationsoftheproperty
261
70.(c)Theproblemstatesthatthesalehas
beenconsummatedandthatKamesinitial
andcontinuinginvestmentsareadequateto
demonstrateacommitmenttopayforthe
property.However,thefactthatEskers
receivableissubjecttofuturesubordination
precludesrecognitionoftheprofitinfull.
Instead,thecostrecoverymethodmustbe
usedtoaccountforthesale.Thedeposit
methodistobeused
1.
Untilthesaleisconsummated,when
all activities necessary for closing
havebeenperformed.
Ifthebuyersinitialandcontinuing
investmentsarenotadequatetodemonstratea
commitmenttopayforthepropertyandthe
sellerisnotreasonablyas
suredofrecoveringthecostofthe
propertyifthebuyerdefaults.
delivereditem,theundelivereditemmustbe
substantiallyinthecontrolofthevendor.
Thereforeanswer(a)iscorrect.
Theproblemstatesthatthesalehasbeen
A.10. ResearchorDevelopment
consummatedandthatKamesinitialand
AccountedforontheMilestone
continuinginvestmentsareadequate.
Method
Therefore,thedepositmethodwillnotbeused
toaccountforthesale.Thereducedprofit
72. (b)Therequirementistoidentifythe
methodisusedonlywhentheinitial
subjectmatterofmilestone
investmentisadequatetodemonstratea
accounting.Answer(b)iscorrect
commitmenttopayforthepropertybutthe
becausethemilestonemethodof
continuinginvestmentsarenot.The
accountingmaybeusedtorecognize
continuinginvestmentsmustalsomeetcertain
revenueforresearchanddevelopment
additionalrequirementsforthereducedprofit
arrangements.Notethatthemilestone
methodtobeused.SinceKamescontinuing
methodisanoption,butitisnot
investmentsareadequate,thereducedprofit
required.
methodwillnotbeusedtoaccountforthe
sale.Thefullaccrualmethodmaybeused
73. (c)Therequirementistoidentifytheamount
onlyifprofitonthesaleisdeterminable,the
ofrevenuerecognizedunderthemilestone
earningprocessisvirtuallycomplete,andall
method.Answer(c)iscorrectbecause
ofthefollowing:
contingentrevenuemayberecognizedinits
1. Asaleisconsummated.
entiretyintheperiodthemilestoneis
2. The buyers initial and continuing
achieved.
investments are adequate to
A.15.InternationalFinancialReporting
demonstrate a commitment to pay
Standards
fortheproperty.
3. Thesellersreceivableisnotsubject
(IFRS)
tofuturesubordination.
74. (d)Therequirementistoidentify
4. Thesellerhastransferredtothebuyer
thebodythatsetsinternational
theusualrisksandrewardsof
accountingstandards.Answer(d)is
ownershipinatransactionthatis,in
correctbecausetheInternational
substance,asaleanddoesnothavea
AccountingStandardsBoard
substantialcontinuinginvolvementin
(IASB)issuesInternational
theproperty.
FinancialReportingStandards.
A.9.MultipleDeliverableRevenue
75. (c)Therequirementistoidentifythe
Arrangements
qualitativecharacteristicsofrelevance.
Answer(c)iscorrectbecausetheIASB
71.(a)Therequirementistoidentifythe
Frameworkprovidesthatrelevanceincludes
conditionthatmustbemettoapplyseparate
thequalitiesofpredictivevalueand
accounting.Foramultipledeliverables
confirmatoryvalue.Answer(a)isincorrect
arrangement,twoconditionsmustbemetfor
becausefeedbackvalueisnotacharacteristic
anitemtobeconsideredaseparateunitof
ofrelevance.Answer(b)isincorrectbecause
accounting:(1)Thedelivereditemhasvalue
thesequalitiesarethecharacteristicsof
onastandalonebasis,and(2)ifthe
reliabilityinFASBConceptStatement1,
arrangementincludesarightofreturnforthe
whichissupersededbySFAC8.
262
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
Answer(d)isincorrectbecausecomparabilityandtimeliness
areenhancingcharacteristicsintheIASBFramework.
76. (b)Therequirementistoidentifytheelementthat
isdefinedasincreasesineconomicbenefitsinthe
formofinflowsorenhancementsofassetsor
decreasesofliabilitiesthatresultinincreasesin
equityotherthanthoseresultingfrom
contributionsfromequityparticipants.Answer(b)
iscorrectbecausetheIASBFrameworkhasfive
elements:asset,liability,equity,income,and
expense.Thedefinitiongivenisthatofincome.
Notethatincomeincludesbothrevenuesand
gains.
77. (b)Therequirementistoidentifythecriteriaunder
IFRSthatmustbemetforanitemtobeincluded
infinancialstatements.Answer(b)iscorrect
becauseinorderforanitemtoberecognizedin
thefinancialstatements,IFRSrequiresthatitmeet
thedefinitionofanelementandcanbemeasured
reliably.
78. (c)Therequirementistoidentifytherevenuerec
ognitionmethodthatmustbeusediftheoutcome
ofrenderingservicescannotbeestimated
reliably.Answer(c)iscorrectbecauseifthe
outcomeofrenderingservicescannotbemeasured
reliably,IFRSrequiresuseofthecostrecovery
method.Answer(a)isincorrectbecausethe
percentageofcompletionmethodisusedwhen
reliableestimatescanbemade.Answer(b)is
incorrectbecausethecompletedcontractmethod
isnotpermissibleunderIFRS.Answer(d)is
incorrectbecausetheinstallmentmethodisa
revenuerecognitionmethodusedunderUS
GAAP,notIFRS.
79. (b)Therequirementistoidentifytheitemthatis
notoneofthecriteriaforrevenuerecognitionfor
salesofgoodsunderIFRS.Answer(b)iscorrect
becauseitisnotrequiredthatpaymenthasbeen
received.
80. (c)Therequirementistoidentifytheassetsfor
whichtheentitymayusefairvalueasdeemedcost
uponadoptionofIFRS.Answer(c)iscorrect
becausetheentitymayusefairvalueasdeemed
costforanyindividualitemofpropertyplantand
equipment.
81. (b)Therequirementistoidentifythefirststep
withinthehierarchyofguidancetowhich
managementreferswhenselectingaccounting
policies.Answer(b)iscorrectbecausethe
highestlevelinthehierarchyisanIFRSstandard
applicabletothetransaction.Answer(a),(c),and
(d)areincorrectbecausetheyallrepresentlowerlevelsin
thehierarchy.
82. (a)Therequirementistoidentifythetransition
date.Answer(a)iscorrectbecausethedateof
transitiontoIFRSisdefinedasthebeginningof
theearliestperiodforwhichanentitypresentsfull
comparativeinformationunderIFRS.
83. (d) The requirement is to identify how
adjustmentsarereflecteduponadoptionofIFRS.
Answer (d) is correct because upon firsttime
adoption of IFRS, any adjustments required to
presenttheopeningbalancesofthestatementof
financialpositionshouldberecognizeddirectlyin
retained earnings or, if appropriate, in another
categoryofequity.
MODULE9 BASICTH.&FIN.REP.:A.BASICCONCEPTS
SOLUTIONSTOSIMULATIONS
TaskBasedSimulation1
Account
Classifications
Authoritative
Literature
Help
Balancesheetclassification
(A)(B)(C)(D)(E)(F)(G)
Incomestatementclassification
(H) (I) (J)
1.Bondspayable,duein2018
2. Treasurystock
3. Accountspayable
4. Salesdiscounts
5.Notespayable,dueinninemonths
6. Inventory
7. Accountsreceivable
8. Commonstock
9.Costofgoodssold
10.Allowanceforuncollectibleaccounts
TaskBasedSimulation2
AccrualBasis
Worksheet
Authoritative
Literature
Help
BaronFlowers
WORKSHEETTOCONVERTTRIALBALANCETOACCRUALBASIS
December31,2010
Accounttitle
Cash
Accountsreceivable
Inventory
Furniture&fixtures
Landimprovements
Accumulateddepreciation
&amortization
Accountspayable
Baron,Drawings
Baron,Capital
Allowanceforuncollectible
accounts
Prepaidinsurance
Accruedexpenses
Estimatedliabilityfromlawsuit
Sales
Purchases
Cashbasis
Dr.
Cr.
25,600
16,200
62,000
118,200
45,000
32,400
17,000
124,600
Adjustments
Dr.
(1)
(4)
15,800
10,800
(9)
(7)
61,000
2,000
(5)
2,900
(3)
13,500
653,000
305,100
Cr.
(6) 14,250
(3) 13,500
(5)
2,600
(2)
3,800
(7) 3,100
(8) 50,000
(1) 15,800
Accrualbasis*
Dr.*
Cr.*
25,600
32,000
72,800
118,200
45,000
61,000
46,650
30,500
125,200
3,800
2,900
318,600
3,100
50,000
668,800
Salaries
Payrolltaxes
Insurance
Rent
Utilities
Livingexpenses
Incomesummaryinventory
Uncollectibleaccounts
Depreciation&amortization
Estimatedlossfromlawsuit
174,000
12,400
8,700
34,200
12,600
13,000
827,000
Completionofthesecolumnswasnotrequired.
(9) 48,000
827,000
(7)
500
(7)
600
(4)
(2)
(6)
(8)
62,000
3,800
14,250
50,000
237,150
(5)
300
(9) 13,000
(4)72,800
237,150
126,000
12,900
8,400
34,200
13,200
10,800
3,800
14,250
50,000
938,850
938,850
264
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
ExplanationsofAdjustments
[1]Toconvert2010salestoaccrualbasis.
Accountsreceivablebalances:
December31,2010
December31,2009
Increaseinsales
[6]Torecord2010depreciationand
amortizationexpense.
Costofleaseholdimprovement
Estimatedlife
Amortization($45,0001/159/12)
Depreciationexpenseonfixturesandequipment
$45,000
15years
2,250
12,000
$14,250
[7]Toconvertexpensestoaccrualbasis.
$30,500
$
Utilities
Payrolltaxes
Balances
December31,
2010
2009
$1,500
$900
1,600
1,100
$3,100
$2,000
[4] Torecordincreaseininventoryfrom
12/31/09to12/31/10.
Inventorybalances:
December31,2010
December31,2009
Increaseininventory
[5]Toadjustprepaidinsurance.
Prepaidbalances:
December31,2010($8,7004/12)
December31,2009($7,8004/12)
Decreaseininsuranceexpense
Increase
inexpenses
$600
500
$1,100
[8]Torecordlawsuitliabilityat12/31/10.
Attorneysestimateofprobableloss
Amountcoveredbyinsurance
Baronsestimatedliability
[9]TorecordBaronsdrawingsfor2010.
$300,000
250,000
$ 50,000
Salary($4,00012)
Livingexpenses
T
C
o
A
u
L
i
1.
2.
C
o
C
I
n
3. T
h
4. E
n
5. T
h
6. A
l
7. I
n
8. T
h
9. T
h
10. A
$48,000
13,000
$61,000
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
265
Explanationofsolutions
1. (E) SFAC 5 states that Relevance is a primary qualitative characteristic. To be
relevant,informationaboutanitemmusthavefeedbackvalueorpredictivevalue(or
both)forusersandmustbetimely.
2. (G) SFAC 6 states that Gains are increases in equity (net assets) from peripheral or
incidentaltransactionsofanentityandfromallothertransactionsandothereventsand
circumstancesaffectingtheentityexceptthosethatresultfromrevenuesorinvestments
byowners.
3. (J)SFAC5statesthatRevenuesandgainsarerealizedwhenproducts(goodsorservices),
merchandise,orotherassetsareexchangedforcashorclaimstocash.
4. (F)SFAC8statesthatComparability,includingconsistency,isanenhancingqualitythat
interactswithrelevanceandfaithfulrepresentationtocontributetotheusefulnessof
information.
5. (A)SFAC5statesthatRecognitionistheprocessofformallyrecordingorincorporating
anitemintothefinancialstatementsofanentityasanasset,liability,revenue,expense,
orthelike.SFAC5continuestherecognitionconceptbystating,Anitemand
informationaboutitshouldmeetfourfundamentalrecognitioncriteriatoberecognized
andshouldberecognizedwhenthecriteriaaremet,subjecttoacostbenefitconstraint
andamaterialitythreshold.
6. (B) SFAC 5 states that Comprehensive income is a broad measure of the effects of
transactionsandothereventsonanentity,comprisingallrecognizedchangesinequity
(net assets) of the entity during a period from transactions and other events and
circumstancesexceptthoseresultingfrominvestmentsbyownersanddistributionsto
owners.
7. (D)SFAC6definesrevenuesasinflowsorotherenhancementsofassetsofanentityor
settlementsofitsliabilities(oracombinationofboth)fromdeliveringorproducing
goods,renderingservices,orotheractivitiesthatconstitutetheentitysongoingmajoror
centraloperations.
8. (L)SFAC5definescurrentmarketvalueastheamountofcash,oritsequivalent,that
couldbeobtainedbysellinganassetinorderlyliquidation.
9. (E) Predictive value is the quality of information that helps users to increase the
likelihoodofcorrectlyforecastingtheoutcomeofpastorpresentevents(SFAC8).
10. (I)SFAC5statesthatEarningsisameasureofperformanceduringaperiodthatis
concernedprimarilywiththeextenttowhichassetinflowsassociatedwithcashtocash
cyclessubstantiallycompleted(orcompleted)duringtheperiodexceed(orarelessthan)
assetoutflowsassociated,directlyorindirectly,withthesamecycles.
TaskBasedSimulation4
TrialBalance
Worksheet
Authoritative
Literature
Help
JaneAlexanderTheater
December31,200X
a)
Equipment
Accumulateddepreciation
equipment
Notespayable
Admissionsrevenue
Advertisingexpense
Salariesexpense
Interestexpense
Depreciationexpense
Interestpayable
Unearnedadmissionsrevenue
Prepaidadvertising
Salariespayable
266
Trialbalance
Debit
Credit
192,000
60,000
90,000
380,000
13,680
57,600
1,400
Adjustments
Debit
Credit
1
3
4
5
2
1
2
3
4
5
Adjustedtrialbalance
Debit
Credit
192,000
9,500
69,500
90,000
330,000
50,000
4,700
1,800
9,500
1,100
1,800
50,000
1,100
12,580
62,300
3,200
9,500
1,800
50,000
1,100
4,700
Incomestatement
Debit
Credit
4,700
MODULE9 BASICTH.&FIN.REP.:A.BASICCONCEPTS
330,000
12,580
62,300
3,200
9,500
TaskBasedSimulation5
Concepts
Authoritative
Literature
Account
Help
(A)(B)(C)(D)(E)
1. Longtermreceivables
2. Availableforsalesecurities
3. Equipment
4. Warrantyobligations
5. Shorttermpayables
6.Accountsreceivable
7. Bondspayable,dueintenyears
8.Tradingsecurities
TaskBasedSimulation6
Adjusting
Entries
Authoritative
Literature
Help
Accrual
1.
Depreciationexpense
Accumulateddeprecation
Interestreceivable
Interestrevenue
Rentexpense
Prepaidrent
Unearnedrevenue
Rentrevenue
Wageexpense
Wagespayable
2.
3.
4.
5.
xx
xx
xx
xx
xx
Deferral
xx
xx
xx
xx
xx
TaskBasedSimulation7
RevenueandExpense
Recognition
Authoritative
Literature
Help
1. Emcosells$5,000ofgoodstoacustomer,FOBshippingpointon12/30/10.
2. Emcosellsthreepiecesofequipmentonacontractoverathreeyearperiod.
Thesalespriceofeachpieceofequipmentis$10,000.Deliveryofeach
pieceofequipmentisonFebruary10ofeachyear.In2010,thecustomer
paida$20,000downpayment,andpaid$5,000peryearin2011and2012.
Collectibilityisreasonablyassured.
5.
3.
4.
On6/1/10,Emcosignsacontractfor$20,000for
goodstobesoldonaccount.Paymentistobemade
intwoinstallmentsof$10,000eachon12/1/11and
12/1/12.Thegoodsaredeliveredon10/1/10.
Collectionisreasonablyassured,andthegoodsmay
notbereturned.
EmcosellsgoodstoacustomeronJuly1,2010,for$50,000.
Ifthecustomerdoesnotsellthegoodstoretailcustomersby
December31,2011,thegoodscanbereturnedtoEmco.The
customersellsthegoodstoretailcustomersonOctober1,
2011.
Amountstoberecognized
2010
2011
2012
5,000
10,000
10,000
10,000
(4,500)
(4,500)
20,000
50,000
MODULE9BASICTH.&FIN.REP.:A.BASICCONCEPTS
Explanationofsolutions
3.
1.
WhengoodsaresoldFOBshippingpoint,titlepassesatthetimethegoodsareshipped.
Therefore,Emcomayrecognizerevenueon12/30/10atthetimethegoodsareshipped.
2.
Revenueisrecognizedwhenearnedandrealizable.Thissaleisnotcompleteuntileach
pieceofequipmentisdelivered.Therefore,Emcoshouldrecognize$10,000eachyear
astheequipmentisdelivered,regardlessofpaymentterms.
Emcoshouldmatchexpensestotheyearinwhichthebenefitsarereceived,whichisoverthe
twoyearperiod.
4.
BecauseEmcodeliveredthegoodsin2010,andcollectibilityisreasonablyassured,
Emcoshouldrecognizeallrevenuein2010.
5.
Becausethereisasalewitharightofreturn,andthebuyermayreturnthemerchandiseif
itisnotsoldtoaretailcustomer,recognitionshouldbedelayeduntiltherightofreturn
hasexpired.
267
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
268
ERRORCORRECTION
MULTIPLECHOICEQUESTIONS(115)
Amount
$5,000
15,000
8,000
Maturitydate
10/31/11
7/31/11
1/31/12
Termofloan
1year
6months
9months
Loebrecordsinterestexpensewhentheloans
arerepaid.Asaresult,interestexpenseof
$1,500wasrecordedin2011.Ifnocorrection
ismade,bywhatamountwould2011interest
expensebeunderstated?
a. $540
b. $620
c. $640
d. $720
2.
During2011,PaulCompany
discoveredthattheending
inventoriesreportedonitsfinancial
statementswereincorrectbythe
followingamounts:
2009
2010
a.
b.
c.
d.
$60,000understated
75,000overstated
Paulusestheperiodicinventorysystemto
ascertainyearendquantitiesthatareconverted
todollaramountsusingtheFIFOcostmethod.
Priortoanyadjustmentsfortheseerrorsand
ignoringincometaxes,Paulsretainedearnings
atJanuary1,2011,wouldbe
Correct.
$15,000overstated.
$75,000overstated.
$135,000overstated.
3.
ConnCo.reportedaretained
earningsbalanceof$400,000at
December31,2010.InAugust
2011,Conndeterminedthat
insurancepremiumsof$60,000for
thethreeyearperiodbeginning
January1,2010,hadbeenpaidand
fullyexpensedin2010.Connhasa
a.
b.
c.
d.
5.
30%incometaxrate.Whatamount
shouldConnreportasadjusted
beginningretainedearningsinits
2011statementofretained
earnings?
$420,000
$428,000
$440,000
$442,000
LoreCo.changedfromthecash
basisofaccountingtotheaccrual
basisofaccountingduring2011.
Thecumulativeeffectofthis
changeshouldbereportedinLores
2011financialstatementsasa
a.
c.
d.
6.
a.
b.
c.
d.
7.
OnJanuary2,2011,Air,Inc.agreedtopayits
formerpresident$300,000underadeferred
compensationarrangement.Airshouldhave
recordedthisexpensein2010butdidnotdo
so.Airsreportedincometaxexpensewould
havebeen$70,000lowerin2010hadit
properlyaccruedthisdeferredcompensation.
InitsDecember31,2011financialstatements,
Airshouldadjustthebeginningbalanceofits
retainedearningsbya
a. $230,000credit.
b. $230,000debit.
c. $300,000credit.
d. $370,000debit.
8.
Straightlinemethod
Yes
Yes
No
No
Productionorusemethod
No
Yes
No
Yes
9.Attheendof2010,RitzcarCo.failedto
accruesalescommissionsearnedduring2010
butpaidin2011.Theerrorwasnotrepeated
in2011.Whatwastheeffectofthiserroron
2010endingworkingcapitalandonthe2011
endingretainedearningsbalance?
a.
b.
c.
d.
2010ending
workingcapital
Overstated
Noeffect
Noeffect
Overstated
2011ending
retainedearnings
Overstated
Overstated
Noeffect
Noeffect
10.OnDecember31,2011,specialinsurance
costswereincurredandunpaid,butwerenot
recorded.Iftheseinsurancecostswere
relatedtoaparticularjoborderinworkin
processthatwasnotcompletedduringthe
period,whatistheeffectoftheomissionon
accruedliabilitiesandretainedearningsinthe
December31,2011balancesheet?
a.
b.
c.
d.
Accruedliabilities
Noeffect
Noeffect
Understated
Understated
Retainedearnings
Noeffect
Overstated
Noeffect
Overstated
11.Whichofthefollowingerrorscould
resultinanoverstatementofbothcurrent
assetsandstockholdersequity?
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
a.
12. GalaxyCorporationhadthefollowing
financialstatementinformation:
Revenue
Expenses
Netincome
2011
$135,000
98,000
37,000
2010
$100,000
65,000
35,000
Totalassets
Totalliabilities
Totalownersequity
12/31/11
$157,000
50,000
107,000
12/31/10
$105,000
35,000
70,000
Galaxyfailedtorecord$12,000ofaccruedwages
attheendof2010.Thewageswererecordedand
paidinJanuary2011.Assumingthatthecorrect
accrualsweremadeonDecember31,2011,what
arethecorrectedbalancesinthe2010and2011
restatedfinancialstatements?
a.
b.
c.
d.
2010
netincome
$23,000
$47,000
$23,000
$23,000
Dec.31,2010
totalliabilities
$23,000
$47,000
$35,000
$47,000
Dec.31,2011
totalowners
equity
$95,000
$107,000
$95,000
$107,000
13. JustinCorporationdiscoveredanerror
intheir2011financialstatementsafter
thestatementswereissued.This
requiresthat
a. Thecumulativeeffectofthe
errorisreportedonthe2012
incomestatementasa
cumulativeeffectofchangein
accountingprinciple.
b. The cumulative effect of the error is
reportedinthe2012beginningbalanceof
eachrelatedaccount.
c.
d.
Anadjustmenttobeginning
retainedearningsin2012with
afootnotedisclosure
describingtheerror.
14. During2012,KellyCorporation
discoveredthatendinginventory
reportedinits2011financialstatements
wasunderstatedby$10,000.How
shouldKellyaccountforthis
understatement?
a. Adjustthebeginninginventory
d.
269
balancein2012by
$10,000.
b. Restate
the
financialstatements
with corrected bal
ances for all
periodspresented.
c. Adjust the
ending balance
in the 2012
retained
earnings
account.
Make no entry because the
errorwillselfcorrect.
15. JacksonCompanyuses
IFRStoreportitsfinancial
results.Duringthecurrent
year,thecompany
discoveredithadoverstated
salesintheprioryear.How
shouldthecompanyhandle
thisissue?
a. Adjust sales for the current
period.
b. Spread
the
adjustment over
the current and
futureperiods.
c. Present
the
cumulative effect
of
the
overstatement as
an item in the
current period
incomestatement.
presentedforcomparativepurposes.
d.
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
270
SIMULATIONS
TaskBasedSimulation1
CorrectedFinancial
Statements
Authoritative
Literature
Help
Situation
CordCorp.,anonpublicenterprise,requiresauditedfinancialstatementsforcreditpurposes.Aftermakingnormaladjust
ingentries,butbeforeclosingtheaccountingrecordsfortheyearendedDecember31,2011,Cordscontrollerpreparedthe
followingfinancialstatementsfor2011:
CordCorp.
STATEMENTOFFINANCIALPOSITION
December31,2011
Assets
Cash
Marketableequitysecurities
Accountsreceivable
Allowancefordoubtfulaccounts
Inventories
Propertyandequipment
Accumulateddepreciation
Totalassets
$1,225,000
125,000
460,000
(55,000)
530,000
620,000
(280,000)
$2,625,000
LiabilitiesandStockholdersEquity
Accountspayableandaccruedliabilities
Incometaxpayable
Commonstock,$20par
Additionalpaidincapital
Retainedearnings
Totalliabilitiesandstockholdersequity
$ 1,685,000
110,000
300,000
75,000
455,000
$ 2,625,000
Netsales
Operatingexpenses:
Costofsales
Sellingandadministrative
Depreciation
Totaloperatingexpenses
Incomebeforeincometax
Incometaxexpense
Netincome
CordCorp.
STATEMENTOFINCOME
FortheYearEndedDecember31,2011
$1,700,000
570,000
448,000
42,000
1,060,000
640,000
192,000
$ 448,000
Cordstaxrateforallincomeitemswas30%forallaffectedyears,anditmadeestimatedtaxpaymentswhendue.Cord
hasbeenprofitableinthepastandexpectsresultsinthefuturetobesimilarto2011.Duringthecourseoftheaudit,the
followingadditionalinformation(notconsideredwhentheabovestatementswereprepared)wasobtained:
1.
2.
4.
Theinvestmentportfolioconsistsofshortterminvestments,classifiedasavailableforsale,forwhichtotalmarket
valueequaledcostatDecember31,2010.OnFebruary2,2011,Cordsoldoneinvestmentwithacarryingvalueof
$100,000for$130,000.Thetotalofthesaleproceedswascreditedtotheinvestmentaccount.
AtDecember31,2011,themarketvalueoftheremainingsecuritiesintheportfoliowas$142,000.
3. The$530,000inventorytotal,whichwasbasedonaphysicalcountatDecember31,2011,waspricedatcost.Subse
quently,itwasdeterminedthattheinventorycostwasoverstatedby$66,000.AtDecember31,2011,theinventorys
marketvalueapproximatedtheadjustedcost.
Pollution control devices costing $48,000, which is high in relation to the cost of the original equipment, were
installedonDecember29,2010,andwerechargedtorepairsin2010.
5. TheoriginalequipmentreferredtoinItem4,whichhadaremainingusefullifeofsixyearsonDecember29,2010,
isbeingdepreciatedbythestraightlinemethodforbothfinancialandtaxreporting.
6. AlawsuitwasfiledagainstCordinOctober2011claimingdamagesof$250,000.Cordslegalcounselbelievesthat
anunfavorableoutcomeisprobable,andareasonableestimateofthecourtsawardtotheplaintiffis$60,000,
whichwillbepaidin2012ifthecaseissettled.
7. Corddeterminedthatitsaccumulatedbenefitsobligationunderthepensionplanexceededthefairvalueofplan
assetsby$40,000atDecember31,2011.Cordhasunrecognizedpriorservicecostof$50,000atDecember31,2011.
Cordfundsthetotalpensionexpenseeachyear.
CompletethefollowingamountsinthecorrectedfinancialstatementsforCordCorp.
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
271
CordCorp.
STATEMENTOFFINANCIALPOSITION
December31,2011
Assets
Cash
Marketableequitysecurities
Accountsreceivable
Allowancefordoubtfulaccounts
Inventories
Deferredtaxasset
Propertyandequipment
Accumulateddepreciation
Totalassets
LiabilitiesandStockholdersEquity
Accountspayableandaccruedliabilities
Incometaxpayable
Estimatedliabilityfromlawsuit
Pensionliability
Commonstock,$20par
Additionalpaidincapital
Retainedearnings
Othercomprehensiveincome
Totalliabilitiesandstockholdersequity
Netsales
Operatingexpenses:
Costofsales
Sellingandadministrative
Depreciation
Pensioncost
Totaloperatingexpenses
Otherincome/loss:
Gain(loss)onmarketablesecurities
Estimatedlossfromlawsuit
Incomebeforeincometax
Incometaxexpense
Netincome
TaskBasedSimulation2
Effectof
Error
Authoritative
Literature
Help
Situation
KlausCorporationhad$580,000ininventory,whichwasbasedonaphysicalcountatDecember31,2011.Theinventory
waspricedatcost.InFebruary2012,itwasdeterminedthattheinventorycostwasoverstatedby$50,000.
Indicatetheeffectsoftheinventoryoverstatementinthe2011and2012financialstatementsbycompletingthe
followingtable.Markeachitemoverstate,understate,orOK.
2011Effects
Inventoryonbalancesheet
Costofgoodssold
Netincome
Retainedearnings
(Overstate)
TaskBasedSimulation3
Research
Authoritative
Literature
Help
(Understate)
2012Effects
(OK)
(Overstate)
(Understate) (OK)
AssumethatyouareassignedtotheauditofYoungCorporation.Younghasdeterminedthatitissuedfinancialstatements
intheprioryearwithamaterialerrorintheapplicationofanaccountingprinciple.WhichsectionoftheProfessionalStandards
addressestheissueofhowtoaccountforthissituation?
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
272
Enteryourresponseintheanswerfieldsbelow.
TaskBasedSimulation4
Concepts
Authoritative
Literature
Situation
1.
2.
3.
4.
5.
T
h
A
c
A
A
A
A
Help
Analysisof
Authoritative
Literature
Error
Help
Situation
TheauditorsofCardiffCompanyhavefoundthefollowingerrorsinthecompanysaccounting
records.
IndicatehowtheerrorwillaffectthecurrentyearsfinancialstatementsbychoosinganOin
thecolumnforoverstateandUinthecolumnforunderstate.
5.
1.
Cardiff fails to
record a sale on
account for
$8,000.
2.
Theinventorywas
miscountedatyearend
andoverstatedby
$5,000.
3.
Cardifffailstorecord
depreciation expense
of $3,500 for the
year.
4.
The
company
receives a utility bill
for $400 on
December 29, but
failstorecordthebill.
Availableforsale
securitieswerenotmarked
tomarket.Lateranalysis
revealsthatthesecurities
increasedinvalueby
$4,000asoftheendofthe
currentyear.Cardiffdoes
notelectthefairvalue
optionforanyofits
availableforsalese
curities.
Assets
(O) (U)
6.
Liabilities
(O) (U)
Retained
earnings
(O) (U)
Netincome
(O) (U)
Other
comprehensiveincome
(O) (U)
Cardiff fails to
accrue wages of
$17,000attheend
oftheyear.
7.
Tradingsecuritieswerenot
markedtomarket.Later
analysisrevealsthatthe
securitiesdeclinedinvalue
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
by$8,000asoftheendof
thecurrentyear.
273
Assets
(O) (U)
Retained
earnings
(O) (U)
Liabilities
(O) (U)
Other
comprehensiveincome
(O) (U)
Netincome
(O) (U)
TaskBasedSimulation6
Research
Authoritative
Literature
Help
AssumethatyouareassignedtotheauditofHughesCorporation.Hughesisattemptingto
determinewhetheranerrorintheprioryearsfinancialstatementismaterial.Whichsectionofthe
ProfessionalStandardsprovidesguidanceonthismatter?
Enteryourresponseintheanswerfieldsbelow.
MODULE9
274
BASICTH.&FIN.REP.:B.ERRORCORRECTION
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
a
c
b
b
__
__
__
__
__
__
__
__
5. a
6. c
7. b
__ __
__ __
__ __
8. b
9. d
10. c
__ __
__ __
__ __
11. d
12. d
13. c
__ __
__ __
__ __
14. b
__ __
15. d
__ __
1st:
__/15=__%
2nd: __/15=__%
MULTIPLECHOICEANSWEREXPLANATIONS
[$40,000($30%$40,000)].This
shouldincreasebeginningretained
earningsbecausethe
understatementof12/31/10
inventorywouldhaveresultedinan
overstatementofcostofgoodssold
andthereforeanunderstatementof
retainedearnings.Thus,the
adjustment1/1/11retainedearnings
is$178,000($150,000+$28,000).
Tacksjournalentrytorecordthe
adjustmentis
B. ErrorCorrection
1.
(a)Thecorrectamountof2011interestexpenseis
$2,040,ascomputedbelow.
11/1/10note
Interestfrom1/1/11to10/31/11
($5,00012%10/12)
2/1/11note
Interestfrom2/1/11to7/31/11
($15,00012%6/12)
5/1/11note
Interestfrom5/1/11to12/31/11
($8,00012%8/12)
Total2011interest
Inventory
Retainedearnings
Taxespayable
(c)Theerrorinunderstatingthe
2009endinginventorywouldhave
selfcorrectedby1/1/11(2009
incomeunderstatedby$60,000;
2010incomeoverstatedby
$60,000).Theerrorinoverstating
the2010endinginventorywould
nothavebeencorrectedby1/1/11.
Thiserroroverstatesboth2010
incomeandthe1/1/11retained
earningsbalanceby$75,000.
3.
(b)Acorrectionofanerroris
treatedasapriorperiodadjustment,
recordedintheyeartheerroris
discovered,andisreportedinthe
financialstatementsasanad
justmenttothebeginningbalance
ofretainedearnings.The
adjustmentisreportednetofthe
relatedtaxeffect.Inthiscasethe
netoftaxeffectis$28,000
4.
5.
40,000
(b)Acorrectionofanerroris
treatedasapriorperiod
adjustmentandisreportedinthe
financialstatementsasan
adjustmenttothebeginning
balanceofretainedearningsin
theyeartheerrorisdiscovered.
Theadjustmentisreportednetof
therelatedtaxeffect.In2010,
insuranceexpenseof$60,000was
recorded.Thecorrect2010
insuranceexpensewas$20,000
($60,0001/3).Therefore,
beforetaxes,1/1/11retained
earningsisunderstatedby
$40,000.Thenetoftaxeffectis
$28,000[$40,000(30%
$40,000)],sotheadjusted
beginningretainedearningsis
$428,000($400,000+$28,000).
(a)Achangeinaccountingprincipleisa
changefromonegenerallyaccepted
28,000
12,000
principletoanothergenerallyaccepted
principle.Acorrectionofanerroris
thecorrectionofamathematicalmistake,a
mistakeintheapplicationofanaccounting
principle,anoversightormisuse
ofexistingfacts,orachangefroman
unacceptableprincipletoagenerally
acceptedone.Therefore,aswitchfromthe
cashbasis(unacceptable)totheaccrualbasis
(acceptable)isacorrectionofanerror
reportedasapriorperiodadjustment.
6. (c)Therequirementistodeterminethe
effectofinventoryerrorsoncostofgoods
sold. The effect of the errors on Brens
2011 cost of goods sold (CGS) is illus
tratedbelow.
BI
+
P
GAFS
EI
CGS
$26,000
CGSunderstated$26,000
(+$52,000)
CGSunderstated52,000
CGSunderstated$78,000
Beginninginventoryisthestartingpointfor
theCGScomputation,soBIerrorshavea
directeffectonCGS.Theunderstatementof
BI($26,000)causesanunderstatementof
goodsavailableforsale(GAFS)andthusof
CGS.Endinginventoryissubtractedinthe
CGScomputation,soEIerrorshavean
inverseeffectonCGS.Theoverstatementof
EI($52,000)meansthattoomuchwas
subtractedintheCGScomputation,causing
anotherunderstatementofCGS.Therefore,
CGSisunderstatedbyatotalof$78,000.
7.
(b)Thefailuretorecordthe$300,000of
deferredcompensationexpensein2010is
consideredanerror.Theprofessionrequiresthat
thecorrectionofanerrorbetreatedasaprior
periodadjustment.Thus,therequirementisto
determinetheretroactiveadjustmentthatshould
bemadetothebeginningbalanceoftheretained
earningsfor2011(includinganyincometax
effect).Thenetadjustmenttobeginningretained
earningswouldbeadebitfor$230,000
($300,000lesstheincometaxbenefitof
$70,000).
8.
(b)Thedepreciablebaseusedto
computedepreciationexpense
underboththestraightlineand
productionmethodsisequaltothe
costlessestimatedsalvagevalueof
theasset.Depreciationexpenseis
overstatedandnetincomeis,
therefore,understatedwhenthe
estimatedsalvagevalueisexcluded
fromthedepreciationcomputation
underbothofthesemethods.
9.
(d)TheentryRitzcarshouldhave
madetoaccruesalescommissions
earnedbutunpaidattheendofits
2010fiscalyearis
Commissionexpense
Commissionspayable
xxx
xxx
SinceCommissionspayableisacurrent
liability,the2010endingworkingcapitalis
overstatedduetoRitzcarsfailuretorecord
thisentry.Sincethiserrorwasnotrepeatedat
theendofRitzcars2011fiscalyear,the
incomeimpactofthe2010errorself
correctedduring2011,whenRitzcarrecorded
boththeearnedbutunpaid2010commissions
plusthe2011earnedcommissions.Therefore,
the2011
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
endingretainedearningswouldnotbe
impactedbytheerror.
10. (c)Aliabilityisaccruedwhenan
obligationtopayorperform
serviceshasbeenincurred.Thisis
thecaseeveniftheliabilitywillnot
besatisfieduntilafuturedate.
Therefore,accruedliabilitieswillbe
understatedontheDecember31,
2011balancesheetbecausethe
specialinsurancecostswerenot
recorded.However,therewillbeno
effectontheDecember31,2011
balanceofretainedearningsbecause
thesecostsrelatetoworkinprocess,
andworkinprocessdoesnotaffect
netincomecurrently.Pleasenote
thatifthespecialinsurancecosts
relatedtogoodsthatweresold,cost
ofgoodssoldwouldhavebeen
understatedthatwouldhavecaused
bothnetincomeandretained
earningstobeoverstated.
11. (d)Theclassificationofholidaypay
expenseforadministrative
employeesasmanufacturing
overheadwouldresultinthe
capitalizationofsomeorallofthese
costsasacomponentofending
inventory,whilethesecostsshould
beexpensedasincurred.Thiserror
couldoverstateendinginventory,a
currentasset.Theoverstatementof
endinginventoryalsounderstates
thecostofgoodssold(Beginning
inventories+Netpurchases
Endinginventories=Costofgoods
sold),andoverstatesnetincome
andstockholdersequity.The
understatementofaccruedsales
expenseswouldnotaffectcurrent
assets.Themisclassificationofthe
noncurrentnotereceivableprinci
palasacurrentassetwouldhaveno
impactonstockholdersequity.The
understatementofdepreciationon
manufacturingmachinerywould
understatetheoverheadaddedto
inventories,acurrentasset.
12. (d)Theentryforthe12/31/10wage
accrualshouldhavebeen
Wagesexpense
Wagespayable
12,000
12,000
Failuretoaccruewageexpenseresultsinan
understatementofwageexpenseandan
understatementofwagespayableby$12,000
in2010.Asaresult,netincomeandretained
earningsareoverstatedby$12,000in2010.
Thewageswereexpensedandpaidin2011.
Therefore,wageexpensefor2011is
overstated,and2011netincomeis
understatedby$12,000.Thisisa
counterbalancingerror,andendingretained
earningsin2011wouldbecorrect.Although
thisisaselfcorrectingerror,thefinancial
statementsmustberestatedwithperiod
specificeffects.Therestatedfinancial
statementsare
275
GalaxyCorporation
RESTATEDFINANCIAL
STATEMENTS
Revenue
Expenses
Netincome
2011
$135,000
86,000
49,000
2010
$100,000
77,000
23,000
Totalassets
Totalliabilities
Totalownersequity
12/31/11
$157,000
50,000
107,000
12/31/10
$105,000
47,000
58,000
13.(c)Thefinancialstatementsofall
periodsshouldberestatedandcorrections
madetoreflectanyperiodspecificeffects
oftheerror.Answer(a)isincorrectbecause
thisisanerror,notachangeinaccounting
principle.Answer(b)isincorrectbecause
althoughthe
assetaccountsmaybeadjustedtoreflect
correctionofanerror,incomestatement
effectsmustalsobedisclosed.Answer(d)
isincorrectbecausethefinancialstatements
mustberestatedforallperiodspresented.
14. (b)Thefinancialstatementsmustberestated
forallperiodspresentedwithperiodspecific
effectsdisclosed.Answer(a)isincorrect
becausealthoughbeginninginventorymaybe
adjusted,prioryearsfinancialstatements
mustalsoberestated.Answer(c)isincorrect
becausecorrectingthebalanceofending
retainedearningsisnotsufficientdisclosure
forerrorcorrection.Answer(d)isincorrect
becauseeventhoughitisaselfcorrecting
error,financialstatementsmustberestated
withperiodspecificeffectsoftheerror.
15. (d)Therequirementistoidentifyhow
anoverstatementofsalesinprioryear
financialstatementshouldbetreated
underIFRS.Answer(d)iscorrectbe
causetheoverstatementisanerror
whichmustbeaccountedforby
restatingtheprioryearfinancial
statements.
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
276
SOLUTIONSTOSIMULATIONS
TaskBasedSimulation1
CorrectedFinancial
Statements
Authoritative
Literature
Help
Thebestwaytocalculatethenewfinancialstatementamountsistomaketherequiredadjustingentriestocorrect
theaccountbalancesasshownbelow.
CordCorp.
ADJUSTINGJOURNALENTRIES
December31,2011
(Explanationsnotrequired)
Dr.
(1)
Marketableequitysecurities
Realizedgainonsaleofmarketableequitysecurities
(2)
Unrealizedlossonmarketableequitysecurities(othercomprehensiveincome)
Adjustmenttoreducemarketableequitysecuritiestomarketvalue
Costofsales
Inventories
Propertyandequipment
Incometaxpayable
(3)
(4)
$30,000
13,000
66,000
48,000
Retainedearnings
Depreciation
Accumulateddepreciation
Estimatedlossfromlawsuit
Estimatedliabilityfromlawsuit
Deferredpensioncost
Additionalpensionliability
Deferredtaxasset
Incometaxpayable
Incometaxexpense
Cr.
$30,000 [a]
13,000 [b]
66,000
14,400 [c]
33,600 [c]
(5)
(6)
(7)
(8)
8,000
60,000
40,000
21,900 [i]
13,200 [ii]
8,000 [d]
60,000
40,000
35,100 [iii]
SupportingComputationsforNumber8
Correctedtotalincometaxexpensefor2011
Incomebeforeincometax,asreported
Addadjustmentincreasingincome
Realizedgainonsaleofsecurities
Deductadjustmentsdecreasingincome
Increasecostofsalesforinventoryoverstatement
Depreciationonpollutioncontroldevices
Adjustedtaxableincomebeforeincometax
$640,000
30,000 [1]
670,000
$66,000
8,000
Correctedcurrentportionincometaxexpenseandincometaxespayable($596,00030%)
Deferredincometaxbenefitsbasedonfollowingtemporarydifferences:
Lawsuitexpectedtobesettledin2012
Unrealizedlossonshorttermmarketableequitysecurities
Totalfuturedeductibleamounts
74,000
$596,000
$178,800
$60,000 [6]
13,000 [2]
$73,000
[i]Deferredtaxbenefitoffuturedeductibleamounts($73,00030%)
Correctedtotalincometaxexpense
21,900
$156,900
[ii]Incometaxexpenseasreported(allcurrent,nodeferred)
Correctedincometaxpayableandincometaxexpense
$192,000
178,800
$13,200
[iii]Incometaxexpense,asreported
Correctedtotalincometaxexpense
$192,000
156,900
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
$35,100
ExplanationsofAmounts
[a]Gainonsaleofmarketableequitysecurities
Sellingprice
Cost
Gain
$130,000
100,000
$ 30,000
[b]Adjustmenttoreducemarketableequitysecuritiestomarketvalue
Marketableequitysecurities,atcost
Balance,2/2/11asreported
Adjustmentforrecordingerror
Adjustedbalance,12/31/11
Marketvaluation,12/31/11
Adjustmentrequired,12/31/11
$125,000
30,000
155,000
142,000
$ 13,000
[c]Prioryearadjustmentforpollutioncontroldevices
Costofinstallation,12/29/10
Deductincometaxeffect($48,00030%)
Creditadjustmenttoretainedearnings,1/1/11
$ 48,000
14,400
$ 33,600
[d]Depreciationfor2011onpollutioncontroldevices
Costoftheinstallationon12/29/10
Depreciationfor2011($48,0006years)
$ 48,000
$ 8,000
CordCorp.
STATEMENTOFFINANCIALPOSITION
December31,2011
Assets
Cash
Marketableequitysecurities
Accountsreceivable
Allowancefordoubtfulaccounts
Inventories
Deferredtaxasset
Deferredpensioncost
Propertyandequipment
Accumulateddepreciation
Totalassets
$1,225,000
142,000
460,000
(55,000)
464,000
21,900
40,000
668,000
(288,000)
$2,677,900
LiabilitiesandStockholdersEquity
Accountspayableandaccruedliabilities
Incometaxpayable
Estimatedliabilityfromlawsuit
Pensionliability
Commonstock,$20par
Additionalpaidincapital
Retainedearnings
Othercomprehensiveincome
Totalliabilitiesandstockholdersequity
$1,685,000
111,200
60,000
40,000
300,000
75,000
419,700
(13,000)
$2,677,900
Calculationofcorrectedretainedearnings:
Previousretainedearnings(incorrect)
Less:Netincomefor2011(incorrect)
Beginningofyearretainedearnings(correct)
Netincome(corrected)
Priorperiodadjustmentforaccountingerrorinexpense
pollutioncontroldevicesin2010
Correctedretainedearnings
455,000
(448,000)
7,000
379,100
33,600
419,700
CordCorp.
STATEMENTOFINCOME
FortheYearEndedDecember31,2011
Netsales
Operatingexpenses:
Costofsales
Sellingandadministrative
Depreciation
Totaloperatingexpenses
Otherincome/loss:
Gain(loss)onmarketablesecurities
Estimatedlossfromlawsuit
Incomebeforeincometax
Incometaxexpense
Netincome
$1,700,000
(636,000)
(448,000)
(50,000)
(1,134,000)
30,000
(60,000)
536,000
(156,900)
379,100
277
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
278
TaskBasedSimulation2
Effectof
Error
Authoritative
Literature
Help
2011Effects
(Overstate)
Inventoryonbalancesheet
Costofgoodssold
Netincome
Retainedearnings
2012Effects
(Understate) (OK)
(Overstate)
(Understate) (OK)
TaskBasedSimulation3
Research
Authoritative
Literature
ASC
250
10
Help
45
23
TaskBasedSimulation4
Concepts
Authoritative
Literature
Help
(T)
(F)
1.
Accountingerrorsarereportedasadjustmentstotheendoftheyearretainedearningsinthecurrentyearsfinancial
statements.
2.
Aselfcorrectingerrorneednotbereportedasanerrorifithascorrecteditselfinthecurrentyear.
3.
Achangeindepreciationmethodistreatedasanerrorwhenadjustingthefinancialstatementsforthecurrentyear.
4.
Anaccountingerroristreatedasapriorperiodadjustment.
5.
Achangeintheusefullivesofassetsincalculatingdepreciationistreatedasanaccountingerrorand
accumulateddepreciationisadjustedtoreflectthiserror.
Explanationofsolutions
1.
2.
False.Accountingerrorsrequireanadjustmenttothebeginningoftheyearretainedearningsinthecurrentyear
financialstatements.
False.Aselfcorrectingerrorwouldrequireanadjustmenttocorrectcomparativeyearfinancialstatements.Adjustmentsto
comparativeyearsshouldbemadetoreflectretroactiveapplicationofthepriorperiodadjustmenttotheaccountsaffected.
3.
False.Achangeindepreciationmethodistreatedasaccumulativeeffectofchangeinaccountingprinciple.
4.
True.Correctionoferrorsinvolverestatementsofpriorperiods.
5.
False.Achangeintheusefullivesofanassetistreatedonaprospectivebasis,anddepreciationforthecurrent
yeariscalculatedbasedonbookvaluedividedbytheestimatednumberofyearsremaining.
TaskBasedSimulation5
Analysis
ofError
Authoritative
Literature
1.Cardifffailstorecordasaleon
accountfor$8,000.
Help
Assets
(O) (U)
Liabilities
(O) (U)
Retained
earnings
(O) (U)
Netincome
(O) (U)
Other
comprehensiveincome
(O) (U)
MODULE9BASICTH.&FIN.REP.:B.ERRORCORRECTION
5.
2.
Theinventorywasmiscounted
atyearendandoverstatedby
$5,000.
3.
4.
Thecompanyreceivesautility
billfor$400onDecember29,
butfailstorecordthebill.
Availableforsalesecuritieswere
notmarkedtomarket.Lateranaly
sisrevealsthatthesecuritiesin
creasedinvalueby$4,000asofthe
endofthecurrentyear.Cardiffdoes
notelectthefairvalueoptionfor
anyofitsavailableforsale
securities.
279
Assets
(O) (U)
6.
7.
Liabilities
(O) (U)
Retained
earnings
(O) (U)
Cardifffailstoaccruewagesof
$17,000attheendoftheyear.
Tradingsecuritieswerenotmarkedto
market.Lateranalysisrevealsthatthe
securitiesdeclinedinvalueby$8,000
asoftheendofthecurrentyear.
Explanationofsolutions
Netincome
(O) (U)
Other
comprehensiveincome
(O) (U)
7.
1.
CardiffshouldhavedebitedAccountsReceivableandcreditedSales.Therefore,accountsreceivableisunderstated,
andretainedearningsisunderstated.
2.
Cardiffhasoverstatedendinginventory,whichunderstatescostofgoodssold.Understatingcostofgoodssold
results in income being overstated for the period. Net income flows into retained earnings, and thus, retained
earningsisalsooverstatedinthecurrentperiod.
3.
CardiffshouldhavedebitedDepreciationExpenseandcreditedAccumulatedDepreciation.Bynotmakingthisentry,
depreciationexpenseistoolow,overstatingnetincome,andoverstatingretainedearnings.Accumulated
depreciationisalsotoolow,whichoverstatesassets.
4.
TheentrywouldbetodebitUtilityExpenseandcreditAccountsPayable.Failingtomakethisentrywouldunderstate
expenses,whichresultsinoverstatednetincome,overstatedretainedearnings,andunderstatedliabilities.
5.
Theunrealizedgainonavailableforsalesecuritiesisnotrecognizedinnetincome,butisrecognizedasan
unrealizedgaininothercomprehensiveincome.Failingtomarktomarketwhenanavailableforsalesecurityhas
increasedinvaluewouldresultinunderstatingassetsandunderstatingothercomprehensiveincomeforthe
period.
6.
ThejournalentrytoaccruewagesistodebitWageExpenseandcreditWagesPayable.Failuretoaccruewages
resultsinexpensesbeingunderstated,whichinturn,overstatesnetincomeandoverstatesretainedearningsforthe
period.Failuretoaccruewagesalsoresultsinliabilitiesbeingunderstated.
Theunrealizedgainsandlossesfromtradingsecuritiesshouldbeincludedinnetincomefortheperiod.Failuretomarkto
marketandrecognizethelosswouldresultinassetsbeingoverstated,netincomebeingoverstated,andretainedearningsbeing
overstatedfortheperiod.
TaskBasedSimulation6
Research
Authoritative
Literature
ASC
250
10
Help
45
27
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
280
ACCOUNTINGCHANGES
a.
MULTIPLECHOICEQUESTIONS(129)
a.
b.
c.
d.
1.OnJanuary1,2009,BrayCompany
purchasedfor$240,000amachinewithauseful
lifeoftenyearsandnosalvagevalue.The
machinewasdepreciatedbythedouble
decliningbalancemethodandthecarrying
amountofthemachinewas$153,600on
December31,2010.Braychangedtothe
straightlinemethodonJanuary1,2011.Bray
canjustifythechange.Whatshouldbethe
depreciationexpenseonthismachineforthe
yearendedDecember31,2011?
$15,360
$19,200
$24,000
$30,720
b.
c.
d.
Items2and3arebasedonthefollowing:
OnJanuary1,2009,WarrenCo.purchaseda
$600,000machine,withafiveyearusefullife
andnosalvagevalue.Themachinewas
depreciatedbyanacceleratedmethodforbook
andtaxpurposes.Themachinescarrying
amountwas$240,000onDecember31,2010.
OnJanuary1,2011,Warrenchangedtothe
straightlinemethodforfinancialreporting
purposes.Warrencanjustifythechange.
Warrensincometaxrateis30%.
a.
b.
c.
d.
2.Inits2011incomestatement,what
amountshouldWarrenreportasthe
cumulativeeffectofthischange?
$120,000
$84,000
$36,000
$0
6.
Cashbasisofaccounting
for vacation pay to the
accrualbasis.
Straightlinemethodof
depreciationforpreviously
recordedassetstothe
doubledecliningbalance
method.
Presentationofstatementsof
individualcompaniestotheir
inclusion in consolidated
statements.
Completedcontract
methodofaccounting
forlongterm
constructiontype
contractstothe
percentageof
completionmethod.
used?
a.
b.
c.
d.
Cumulativeeffectsofchange
inaccountingprinciple
No
No
Yes
Yes
Items7and8arebasedonthefollowing:
During2011,OrcaCorp.decidedtochange
fromtheFIFOmethodofinventoryvaluation
totheweightedaveragemethod.Inventory
balancesundereachmethodwereasfollows:
January1,2011
December31,2011
3.
a.
b.
c.
d.
$120,000
$72,000
$36,000
$0
FIFO
$71,000
79,000
Weightedaverage
$77,000
83,000
Orcasincometaxrateis30%.
2009and3,500during2010.
Hollys income tax rate is 30%. Holly
shouldreporttheaccountingchangeinits2011
financialstatementsasa(n)
a.
Cumulativeeffectofa
change in accounting
principle of $2,000 in
itsincomestatement.
b.
4.
OnJanuary2,2011,tobetterreflect
thevariableuseofitsonlymachine,
Holly,Inc.electedtochangeits
methodofdepreciationfromthe
straightlinemethodtotheunitsof
productionmethod.Theoriginalcost
ofthemachineonJanuary2,2009,
was$50,000,anditsestimatedlife
wastenyears.Hollyestimatesthatthe
machinestotallifeis50,000machine
hours.
Machine hours usage was 8,500 during
Retrospective
application
No
Yes
Yes
No
c.
d.
5.
Cumulativeeffectofa
change in accounting
principle of $1,400 in
itsincomestatement.
Adjustment
to
beginning retained
earningsof$1,400.
Theeffectsofachangeinaccounting
7.
a.
b.
c.
d.
8.
a.
b.
d.
9.
b.
c.
Adecreaseinendinginventoryinthe
2011balancesheet.
Adecreaseinnetincomein2010.
d. A gain from cumulative
effect of change on the in
comestatementin2011.
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
10. Which of the following would receive
treatment as acumulative effect on an
accountingchangeontheincomestatement?
a.
b.
c.
d.
LIFOto
weightedaverage
Yes
Yes
No
No
FIFOto
weightedaverage
Yes
No
No
Yes
11. OnAugust31,2011,HarveyCo.
decidedtochangefromtheFIFO
periodicinventorysystemtothe
weightedaverageperiodicinventory
system.Harveyisonacalendaryear
basis.Thecumulativeeffectofthe
changeisdetermined
a. AsofJanuary1,2011.
b. AsofAugust31,2011.
c. During the eight months
endingAugust31,2011,by
a weightedaverage of the
purchases.
d. Asoftheearliestperiodpresentedif
practicable.
12. In2011,BrightonCo.changedfromthe
individualitemapproachtotheaggregate
approachinapplyingthelowerofFIFOcostor
markettoinventories.Thechangeshouldbe
reportedinBrightonsfinancialstatementsasa
a. Change in estimate on a prospective
basis.
b.
c.
d.
Cumulativeeffectof
changeinaccounting
principleonthecurrent
yearincomestatement.
13. OnJanuary1,2011,PoeConstruction,Inc.
changedtothepercentageofcompletion
methodofincomerecognitionforfinancial
statementreportingbutnotforincometaxre
porting.Poecanjustifythischangein
accountingprinciple.AsofDecember31,2010,
Poecompileddatashowingthatincomeunder
thecompletedcontractmethodaggregated
$700,000.Ifthepercentageofcompletion
methodhadbeenused,theaccumulatedincome
throughDecember31,2010,wouldhavebeen
$880,000.Assuminganincometaxrateof40%
forallyears,thecumulativeeffectofthis
accountingchangeshouldbereportedbyPoeas
a. An increase in
constructionin
progress
for
$180,000inthe2010
balancesheet.
b. A decrease in the
beginning balance of
retained earnings for
c.
d.
281
$108,000in2011.
A cumulative effect
adjustment of $108,000 on
the2011incomestatement.
An increase in
ending retained
earnings
of
$180,000in2010.
14. Theeffectofachangein
accountingprinciplethatis
inseparablefromtheeffectofa
changeinaccountingestimate
shouldbereported
a. Byrestatingthefinancial
statements of all prior
periodspresented.
b. Asacorrectionofanerror.
c. As a component of income
fromcontinuingoperations,
intheperiodofchangeand
futureperiodsifthechange
affectsboth.
d. Asaseparatedisclosure
afterincomefrom
continuingoperations,in
theperiodofchangeand
futureperiodsifthechange
affectsboth.
15. Whichofthefollowingisconsidered
a direct effect of a change in
accountingprinciple?
a. Deferredtaxes.
b. Profitsharing.
c. Royaltypayments.
d. Noneoftheabove.
16. Indirect effects from a change in
accounting principle should be
reported
a. Retrospectively to the earliestperiod
presented.
b. Asacumulativechangein
accountingprinciple inthe
currentperiod.
c. Intheperiodinwhichthe
accounting change oc
curs.
d. Asapriorperiodadjustment.
17. Ifitisimpracticabletodeterminethe
cumulativeeffectofanaccounting
changetoanyofthepriorperiods,
theaccountingchangeshouldbe
accountedfor
a. Asapriorperiodadjustment.
b. Onaprospectivebasis.
c. As a cumulative effect
changeontheincomestate
ment.
d. As an adjustment to
retained earnings in the
firstperiodpresented.
18. Ifthecumulativeeffectofapplying
anaccountingchangecanbe
determinedbuttheperiodspecific
effectsonallperiodscannotbe
determined,thecumulativeeffectof
thechangeshouldbeappliedto
a. Theendbalanceofretained
earnings of the earliest
b.
c.
periodpresented.
Netincomeofthecurrentyear.
Retainedearningsofthecurrentyear.
d. Thecarryingvalueofthe
assetsandliabilitiesatthe
beginningoftheearliest
periodtowhichitcanbe
applied.
19. OnJanuary1,2007,TaftCo.purchaseda
patentfor
$714,000.Thepatentisbeingamortizedover
itsremaininglegallifeoffifteenyearsexpiring
onJanuary1,2019.During2010,Taft
determinedthattheeconomicbenefitsofthe
patentwouldnotlastlongerthantenyears
fromthedateofacquisition.Whatamount
shouldbereportedinthebalancesheetforthe
patent,netofaccumulatedamortization,atDe
cember31,2010?
a. $428,400
b. $489,600
c. $504,000
d. $523,600
20. OnJanuary1,2007,FlaxCo.purchaseda
machinefor$528,000anddepreciateditbythe
straightlinemethodusinganestimateduseful
lifeofeightyearswithnosalvagevalue.On
January1,2010,Flaxdeterminedthatthema
chinehadausefullifeofsixyearsfromthedate
ofacquisitionandwillhaveasalvagevalueof
$48,000.Anaccountingchangewasmadein
2010toreflecttheseadditionaldata.The
accumulateddepreciationforthismachine
shouldhaveabalanceatDecember31,2010,of
a. $292,000
b. $308,000
c. $320,000
d. $352,000
21. Howshouldtheeffectofachange
in accounting estimate be
accountedfor?
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
282
a.
By restating amounts
25. Acompanyhasincludedinitsconsolidated
reportedinfinancialstate
financialstatementsthisyearasubsidiary
mentsofpriorperiods.
acquiredseveralyearsagothatwas
b. By reporting pro forma amounts for
appropriatelyexcludedfromconsolidationlast
priorperiods.
year.Thisshouldbereportedas
c. Asapriorperiodadjustment
a. An accounting change that
to beginning retained
should be reported pro
earnings.
spectively.
d. In the period of change
b. An accounting change
and future periods if the
thatshouldbereported
changeaffectsboth.
retrospectively.
22. During2010,KreyCo.increasedthe
c. Acorrectionofanerror.
estimatedquantityofcopper
d. Neither an accounting
recoverablefromitsmine.Kreyuses
changenoracorrectionof
theunitsofproductiondepletion
anerror.
method.Asaresultofthechange,
26. Whichofthefollowingstatementsis
whichofthefollowingshouldbe
correctregardingaccounting
reportedinKreys2010financial
changesthatresultinfinancial
statements?
statementsthatare,ineffect,the
Cumulativeeffectof
Proformaeffectsof
statementsofadifferentreporting
achangein
retroactiveapplication
entity?
accountingprinciple
ofnewdepletionbase
a. Cumulativeeffect
a.
Yes
Yes
adjustmentsshouldbe
b.
Yes
No
reportedasseparateitems
c.
No
No
onthefinancialstatements
d.
No
Yes
pertainingtotheyearof
23. OakCo.offersathreeyearwarranty
change.
onitsproducts.Oakpreviously
estimatedwarrantycoststobe2%of
sales.Duetoatechnological
advanceinproductionatthebegin
ningof2010,Oaknowbelieves1%
ofsalestobeabetterestimateof
warrantycosts.Warrantycostsof
$80,000and$96,000werereported
in2008and2009,respectively.
Salesfor2010were$5,000,000.
Whatamountshouldbepresentedin
Oaks2010financialstatementsas
warrantyexpense?
a. $50,000
b. $88,000
c. $100,000
d. $138,000
24. For2009,PacCo.estimateditstwo
yearequipmentwarrantycostsbased
on$100perunitsoldin2009.Experi
enceduring2010indicatedthatthe
estimateshouldhavebeenbasedon
$110perunit.Theeffectofthis$10
differencefromtheestimateis
reported
a. In 2010 income from continuing
operations.
b. Asanaccountingchange,
net of tax, below 2010
income from continuing
operations.
c. As an accounting change
requiring 2009 financial
statementstoberestated.
d. As a correction of an error
b.
c.
d.
No restatements or
adjustments are required if
the changes involve
consolidated methods of
accountingforsubsidiaries.
No restatements or
adjustments are required if
thechangesinvolvethecost
or equity methods of ac
countingforinvestments.
The financial statements
of all prior periods pre
sented are adjusted
retrospectively.
thefinancial
statements.
b.
Permittediftheentityencountersnew
transactions,events,orconditionsthat
aresubstantivelydifferentfromexisting
orprevioustransactions.
c.
Requiredformaterialtransactions,if
theentityhadpreviouslyaccounted
forsimilar,thoughimmaterial,
transactionsunderanunacceptable
accountingmethod.
Requiredifanalternateaccounting
policygivesrisetoamaterialchange
inassets,liabilities,orthecurrentyear
netincome.
d.
relevant
information.
d. There is no
prohibition of the
method in the
standards.
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
SIMULATIONS
TaskBasedSimulation1
Accounting
Changes
Authoritative
Literature
Help
Situation
OnJanuary2,2011,Quo,Inc.hiredReedtobeitscontroller.Duringtheyear,Reed,working
closelywithQuospresidentandoutsideaccountants,madechangesinaccountingpolicies,corrected
severalerrorsdatingfrom2010andbefore,andinstitutednewaccountingpolicies.
Quos2011financialstatementswillbepresentedincomparativeformwithits
2010financialstatements.Items1through10representQuostransactions.
ListArepresentspossibleclassificationsofthesetransactionsas:achangeinaccounting
principle,achangeinaccountingestimate,acorrectionofanerrorinpreviouslypresentedfinancial
statements,orneitheranaccountingchangenoranaccountingerror.
ListBrepresentsthegeneralaccountingtreatmentforthesetransactions.Thesetreatmentsare
RetrospectiveapplicationapproachApplythenewaccountingprincipletoallpriorperiods
presentedshowingthecumulativeeffectofthechangeinthecarryingvalueofassetsand
liabilitiesatthebeginningofthefirstperiodpresented,andadjustfinancialstatements
presentedtoreflectperiodspecificeffectsofthechange.
Retroactive restatement approachRestate the 2010 financial statements and adjust 2010
beginningretainedearningsiftheerrororchangeaffectsaperiodpriorto2010financial
statements.
ProspectiveapproachReport2011andfuturefinancialstatementsonthenewbasis,butdo
notrestate2010financialstatements.
ListB(Selectone
Foreachitem,selectonefromListAandonefromListB.
approach)
ListA(Selectonetreatment)
X. Retrospective application
A. Changeinaccountingprinciple.
approach.
B. Changeinaccountingestimate.
Y. Retroactive restatement
C. Correction ofan errorin previouslypresented financial
statements.
Z.
D. Neitheranaccountingchangenoranaccountingerror.
Itemstobeanswered
1.
3.
7.
Quomanufacturesheavyequipmenttocustomer
specificationsonacontractbasis.Onthebasisthatitis
preferable,accountingfortheselongtermcontracts
wasswitchedfromthecompletedcontractmethodto
thepercentageofcompletionmethod.
2.
Asaresultofaproductionbreakthrough,Quo
determinedthatmanufacturingequipment
previouslydepreciatedoverfifteenyearsshouldbe
depreciatedovertwentyyears.
TheequipmentthatQuomanufacturesissoldwitha
fiveyearwarranty.Becauseofaproduction
breakthrough,Quoreduceditscomputationofwarranty
costsfrom3%ofsalesto1%ofsales.
4.
QuochangedfromLIFOtoFIFOtoaccountfor
itsfinishedgoodsinventory.
5.QuochangedfromFIFOtoaveragecosttoaccountfor
itsrawmaterialsandworkinprocessinventories.
6.
approach.
Prospectiveapproach.
8.
During2011,Quo
determinedthatan
insurancepremiumpaidand
entirelyexpensedin2010
wasfortheperiodJanuary
1,2010,throughJanuary1,
2012.
Quochangeditsmethodof
depreciatingofficeequipment
fromanacceleratedmethodto
thestraightlinemethodtomore
closelyreflectcostsinlater
years.
283
ListA
Treatment
(A)(B)(C) (D)
ListB
Approach
(X) (Y) (Z)
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
284
9. Quoinstitutedapensionplanforallemployeesin2011and
adoptedtheaccountingstandardsrelatedtopensions.Quohad
notpreviouslyhadapensionplan.
ListA
Treatment
(A)(B)(C) (D)
ListB
Approach
(X) (Y) (Z)
10. During2011,QuoincreaseditsinvestmentinWorth,Inc.from
a10%interest,purchasedin2010,to30%,andacquiredaseat
onWorthsboardofdirectors.Asaresultofitsincreasedin
vestment,Quochangeditsmethodofaccountingforinvest
mentinsubsidiaryfromthecostadjustedforfairvaluemethod
totheequitymethod.Quodidnot
electtousethefairvaluemethodto
reportits30%investmentinWorth.
TaskBasedSimulation2
Calculations
Authoritative
Literature
Help
Kenthas$500,000inequipmentandmachinerythatwasacquiredonJanuary2,2009.Kent
hasbeenusingthedoubledecliningbalancemethodtodepreciatetheequipmentoveran
estimated10yeareconomiclifewithnosalvage.OnJanuary1,2011,Kentdecidestochangeto
thestraightlinemethodwithnosalvage.Kenthasa40%taxrate.
Calculatethefollowingamounts:
1.
Accumulateddepreciationasof12/31/10
2.
Depreciationexpensefor2011
3.
Accumulateddepreciationasof12/31/11
4.
Indicatetheamountoftheaccountingchangeshownnetoftaxifappropriate
TaskBasedSimulation3
Classification/
Disclosure
Authoritative
Literature
Help
Clarkmadethefollowingchangesinitsaccountingpolicies.
Clarkchangeditsdepreciationmethodforitsproductionmachineryfromthedoubledeclining
balancemethodtothestraightlinemethodeffectiveJanuary1,2011.
Clarkappropriatelychangedthesalvagevaluesusedincomputingdepreciationforitsoffice
equipment.
Clarkappropriatelychangedthespecificsubsidiariesconstitutingthegroupofcompaniesfor
whichconsolidatedfinancialstatementsarepresented.
ForeachoftheitemsthatClarkchanged,identifywhetherClarkshouldshowthefollowingby
choosingYesorNointheappropriatecolumns.
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
Changeitem
3.
1.
Clarkchangedits
depreciationmethodforits
productionmachinery
fromthedoubledeclining
balancemethodtothe
straightlinemethod
effectiveJanuary1,2011.
2.
Clarkappropriately
changedthesalvage
valuesusedincomputing
depreciationforitsoffice
equipment.
Clarkappropriatelychanged
thespecificsubsidiaries
constitutingthegroupof
companiesforwhichcon
solidatedfinancialstatements
arepresented.
285
Cumulativeeffectof
changeinprinciplein
netincomeofthe
periodofchange
Yes
No
Retrospective
applicationtofinancial
statementsofallprior
periodspresented
currently
Yes
No
Proformaeffectsof
retroactiveapplication
forallpriorperiods
presentedcurrently
Yes
No
TaskBasedSimulation4
Research
Authoritative
Literature
Help
AssumethatyouareassignedtotheauditofClarkCorporation.Clarkisconsideringchangingthe
depreciationmethodforitsproductionmachineryfromthedoubledecliningbalancemethodtothe
straightlinemethod.WhichsectionoftheProfessionalStandardsprovidesguidanceonthenatureof
thistypeofchange?
Enteryourresponseintheanswerfieldsbelow.
TaskBasedSimulation5
Treatment
Accounting
Authoritative
Literature
Help
Situation
FalkCo.beganoperationsinJanuary,2010.OnJanuary2,2011,FalkCo.hiredanew
controller.Duringtheyear,thecontroller,workingcloselywithFalkspresidentandoutside
accountants,madechangesinexistingaccountingpolicies,institutednewaccountingpolicies,and
correctedseveralerrorsdatingfrompriorto2011.
FalksfinancialstatementsfortheyearendedDecember31,2011,willnotbepresentedin
comparativeformwithits2010financialstatements.
List A represents possible classifications of these transactions as a change in accounting
principle,achangeinaccountingestimate,correctionofanerrorinpreviouslypresentedfinancial
statements,orneitheranaccountingchangenoranerrorcorrection.
ListBrepresentsthegeneralaccountingtreatmentrequiredforthesetransactions.These
treatmentsare
RetrospectiveapplicationapproachApplythenewaccountingprincipletoallpriorperiods
presentedshowingthecumulativeeffectofthechangeinthecarryingvalueofassetsand
liabilitiesatthebeginningofthefirstperiodpresented,andadjustfinancialstatementspresented
toreflectperiodspecificeffectsofthechange.
RetroactiverestatementapproachAdjust2011beginningretainedearningsiftheerroror
changeaffectsaperiodpriorto2011.
ProspectiveapproachReport2011andfuturefinancialstatementsonthenewbasis,but
donotadjustbeginningretainedearningsorincludethecumulativeeffectofthechange
inthe2011incomestatements.
presented
financial
ListATypeofchange(Selectone)
statements.
A. Changeinaccountingprinciple.
D. Neitheranaccountingchangenoranerror
B. Changeinaccountingestimate.
correction.
C. Correctionofanerrorinpreviously
ListBGeneralaccountingtreatment(Selectone)
X. Retroactiveapplicationapproach.
Y. Retroactiverestatementapproach.
Z. Prospectiveapproach.
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
286
ForItems1and2,selectaclassificationforeachtransactionfromListAandthegeneralaccountingtreatmentrequiredto
reportthechangefromListB.
1.
Falkmanufacturescustomizedequipmenttocustomerspeci
ficationsonacontractbasis.Falkchangeditsmethodof
accountingfortheselongtermcontractsfromthecompleted
contractmethodtothepercentageofcompletionmethodbecause
Falkisnowabletomakereasonableestimatesoffuture
constructioncosts.
2.
Basedonimprovedcollectionprocedures,Falkchangedthe
percentageofcreditsalesusedtodeterminetheallowancefor
uncollectibleaccountsfrom2%to1%.
ListA
Typeofchange
(A)(B)(C)(D)
ListB
Accountingtreatment
(X)(Y)(Z)
TaskBasedSimulation6
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
287
TaskBasedSimulation7
Research
Authoritative
Literature
Help
AssumethatyouareassignedtotheauditofWilsonConstructionCompany.Wilsonisconsideringchangingitsmethod
ofaccountingfromthecompletedcontractmethodtothepercentageofcompletionmethod.Whichsectionofthe
ProfessionalStandardsaddressestheissueofhowtoaccountfortheindirecteffectsofthechange?
Enteryourresponseintheanswerfieldsbelow.
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
288
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
7.
b
d
d
b
b
a
d
__
__
__
__
__
__
__
__
__
__
__
__
__
__
8.
9.
10.
11.
12.
13.
14.
c
a
c
d
c
a
c
__
__
__
__
__
__
__
__
__
__
__
__
__
__
15.
16.
17.
18.
19.
20.
21.
a
c
b
d
b
a
d
__
__
__
__
__
__
__
__
__
__
__
__
__
__
22.
23.
24.
25.
26.
27.
28.
c
a
a
b
d
b
a
__
__
__
__
__
__
__
__
__
__
__
__
__
__
29.c
____
1st:
2nd:
__/29=__%
__/29=__%
MULTIPLECHOICEANSWEREXPLANATIONS
C.1.ChangesinAccountingPrinciples(SFAS154)
1.
(b)Achangeindepreciationmethodisachange
inmethodthatisnotdistinguishablefroma
changeinestimate,andisaccountedforasa
changeinestimate.Thechangeisreportedona
prospectivebasisinthecurrentyearandfuture
years.Bookvalueasof1/1/11=$153,600/8years
remaining=$19,200depreciationexpensein
2011.
2.
(d)Zero.Achangeindepreciationmethodisa
changeinmethodthatisnotdistinguishable
fromachangeinestimate,andisaccountedfor
asachangeinestimate.Thechangeisreported
onaprospectivebasisinthecurrentyearand
futureyears.Achangeindepreciationmethodis
nolongergivencumulativeeffecttreatmenton
theincomestatement.
3.
(d)Zero.Achangeindepreciationmethodisa
changeinmethodthatisnotdistinguishablefrom
achangeinestimate,andisaccountedforasa
changeinestimate.Thechangeisreportedona
prospectivebasisinthecurrentyearandfuture
years.Becauseachangeindepreciationmethodis
nolongergivencumulativeeffecttreatmentonthe
incomestatement,therearenodeferredincome
taxliabilityeffects.
4.
(b)Achangeindepreciationmethodisachange
inmethodthatisnotdistinguishablefroma
changeinestimate,andisaccountedforasa
changeinestimate.Thechangeisreportedona
prospectivebasisinthecurrentyearandfuture
years.
5.
(b)Therequirementistodeterminewhichaccounting
changeshouldbereportedonaprospectivebasis.Achange
indepreciationmethodisachangeinprinciplethatisnot
distinguishablefromachangeinestimate,andisaccounted
forasachangeinestimate.Thechangeisreportedona
prospectivebasisinthecurrentyearandfutureyears.A
changefromthecashbasistotheaccrualbasisof
accountingisachangefromnonGAAPtoGAAP
accountedforasthecorrectionofanerror.Achangein
reportingentityrequiresretrospectiveapplicationtothe
earliestyearpresentedifpracticable.Achangeinthe
methodofaccountingforlongtermcontractsrequires
retrospectiveapplicationtotheearliestyearpresentedif
practicable.
6.
(a)Therequirementistodeterminewhethera
changeindepreciationmethodfromstraightlineto
doubledecliningbalanceshouldbereportedasa
cumulativeeffectofachangeinaccountingprinciple
andreceiveretrospectiveapplication.Achangein
depreciationmethodisachangeinmethodthatisnot
distinguishablefromachangeinestimate,andis
accountedforasachangeinestimate.Thechangeis
reportedonaprospectivebasisinthecurrentyear
andfuture
years.Therefore,itdoesnotreceivecumulative
effecttreatmentorretrospectivetreatment.
7.
8.
(d)Achangeininventorymethodnolongerreceives
cumulativeeffecttreatmentontheincomestatement.In
stead,theaccountingchangeisgivenretrospectiveapplica
tiontotheearliestperiodpresented,ifpracticable.There
fore,theansweriszero.
(c)Achangeininventorymethodnolongerreceives
cumulativeeffecttreatmentontheincomestatement.In
stead,theaccountingchangeisgivenretrospectiveapplica
tiontotheearliestperiodpresented,ifpracticable.
9.
(a)Retrospectiveapplicationrequiresapplying
thenewprincipletotheearliestperiodpresented
ifpracticable.Because2011beginninginventory
isthepreviousyearsendinginventory,thenew
principlecanbeappliedtothe2010financial
statements.Thiswouldresultinanincreasein
endinginventoryinthebalancesheetfor2010,a
decreaseincostofgoodssoldin2010,andan
increaseinthebeginninginventory,whichwould
resultinahighercostofgoodssoldandalower
netincomefor2011.
10. (c)Achangeininventorymethodisgivenretro
spectiveapplicationtotheearliestperiod
presented,ifpracticable.
11. (d)Retrospectiveapplicationrequiresthechange
tobecalculatedfortheearliestperiodpresented
ifpracticable.
12. (c)Achangeininventorymethodnolongerreceives
cumulativeeffecttreatmentontheincomestatement.The
accountingchangeisgivenretrospectiveapplicationtothe
earliestperiodpresented,ifpracticable.
13. (a)Therequirementistoindicatehowachangein
accountingprinciplefromthecompletedcontract
methodtothepercentageofcompletionmethod
shouldbereported.Achangeinthemethodof
accountingforlongtermcontractsrequires
retrospectiveapplicationtotheearliestyearpracti
cable.Thisresultsina$180,000increasein
incomefor2010.Theassetswouldbeadjustedfor
theearliestperiodaffected,andconstructionin
progresswouldincreaseby$180,000.Netincome
for2010wouldincreaseby$108,000($180,000
less40%taxeffects),andthedeferredtaxliability
accountwouldincreasein2010by$72,000.
14. (c)Theeffectofachangeinaccountingprinciple
whichisinseparablefromtheeffectofachangein
accountingestimateshouldbeaccountedforasa
changeinaccountingestimate.Changesin
estimateshouldbeaccountedforintheperiodof
changeandalsoinanyaffectedfutureperiodsasa
componentofincomefromcontinuingopera
tions.Financialstatementsareonlyrestatedfor
changesduetoanerror.Errorsinclude
mathematicalmistakes,mistakes
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
inapplyingaccountingprinciples,oversightsormisuseof
availablefacts,andchangesfromunacceptableaccounting
principlestoGAAP.Thesituationdescribedinthisquestion
doesnotmeetthedescriptionofanerror.
15. (a)Deferredtaxesisadirecteffectfromthe
changeinaccountingprinciple,anditseffects
shouldberecordedintheearliestperiod
presented,ifpracticable.Profitsharingand
royaltypaymentsareindirecteffectsandshould
bereportedintheperiodofthechange.
16. (c)Indirecteffectsofachangeinaccounting
principleshouldbereportedintheperiodin
whichtheaccountingchangeoccurs.Direct
effectsarereportedretrospectivelytothe
earliestperiodpresented,ifpracticable.Answers
(b)and(d)areincorrectsinceaccounting
changesarenolongertreatedascumulative
effectchangesorpriorperiodadjustments.
17. (b)Ifitisimpracticabletodeterminethecumulativeeffect
ofanaccountingchangetoanyofthepriorperiods,the
accountingchangeshouldbeaccountedforonapro
spectivebasis.Answer(a)isincorrectbecauseaccounting
changesarenolongertreatedaspriorperiodadjustments.
Answer(c)isincorrectbecauseaccountingchangesareno
longertreatedascumulativeeffectchangesontheincome
statement.Answer(d)isincorrectbecausethechangewould
notbetoretainedearningsinthefirstperiodpresented.
18. (d)Ifthecumulativeeffectofapplyingan
accountingchangecanbedetermined,butthe
periodspecificeffectsonallperiodscannotbe
determined,thecumulativeeffectofthechange
shouldbeappliedtothecarryingvalueofthe
assetsandliabilitiesatthebeginningofthe
earliestperiodtowhichitcanbedetermined.
C.2.ChangeinAccountingEstimates
19. (b)Thissituationisachangeinaccounting
estimateandshouldbeaccountedforcurrently
andprospectively.From1/1/07to12/31/09,
patentamortizationwasrecordedusingafifteen
yearlife.Yearlyamortizationwas$47,600
($714,00015),accumulatedamortizationat
12/31/09was$142,800($47,6003),andthe
bookvalueofthepatentat12/31/09was
$571,200($714,000$142,800).Beginningin
2010,thisbookvaluemustbeamortizedoverits
remainingusefullifeof7years(10years3
years).Therefore,2010amortizationis$81,600
($571,2007)andthe12/31/10bookvalueis
$489,600($571,200$81,600).
20. (a)From1/1/07to12/31/09,depreciationwas
recordedusinganeightyearlife.Yearly
depreciationwas$66,000($528,0008),and
accumulateddepreciationat12/31/09was
$198,000(3$66,000).In2010,theestimated
usefullifewaschangedtosixyearstotalwitha
salvagevalueof$48,000.Therefore,the
289
12/31/09bookvalue($528,000$198,000=
$330,000)isdepreciateddowntothe$48,000
salvagevalueoveraremainingusefullifeof
threeyears(sixyearstotalthreeyearsalready
recorded).Depreciationexpensefor2010is
$94,000[($330,000$48,000)3],increasing
accumulateddepreciationto$292,000($198,000
+$94,000).
21. (d)Changesinaccountingestimatearetobeac
countedforintheperiodofchangeandinfuture
periodsif
thechangeaffectsboth(i.e.,prospectively).Proforma
amountsarepresentedforchangesinaccountingprinciple
accountedforusingthecurrent(cumulativeeffect)ap
termrestatementrefersonlytocorrectionof
errorsinpreviouslyissuedfinancialstatements.
26. (d)Anaccountingchangethatisachangein
reportingentityisgivenretrospectiveapplication
totheearliestperiodpresented,ifpracticable.The
termrestatementrefersonlytocorrectionof
errorsinpreviouslyissuedfinancialstatements.
C.5.InternationalFinancialReportingStandards
(IFRS)
27. (b)Therequirementistoidentifytheitemthat
describeshowchangesinaccountingprinciples
arereportedunderIFRS.Answer(b)iscorrect
becauseIFRSrequireschangesinaccounting
principlestobereportedbygivingretrospective
applicationtotheearliestperiodpresented.
Answer(a)isincorrectbecauseachangein
accountingestimateisaccountedforona
prospectivebasisinthecurrentandfuture
periods.Answer(c)isincorrectbecauserestate
mentisrequiredforerrorsinthefinancial
statements.Answer(d)isincorrectbecause
cumulativeadjustmentsontheincomestatement
arenotpermitted.
24. (a)Achangeinequipmentwarrantycostsbasedon
additionalinformationobtainedthroughexperience
28. (a)Therequirementistoselecttheitemthatdescribeswhen
qualifiesasachangeinaccountingestimate.Changesin
changesinaccountingpoliciesarepermittedorrequired.
estimateshouldbeaccountedforintheperiodofchangeas
Answer(a)iscorrectbecausechangesarepermittedifit
acomponentofincomefromcontinuingoperationsandin
willresultinamorereliableandmorerelevantpresentation
futureperiodsifnecessary.Norestatementisrequiredfora
ofthefinancialstatements.
changeinestimate.
C.3.ChangeinReportingEntity(ASCTopic250)
25. (b)Anaccountingchangethatisachangein
reportingentityisgivenretrospectiveapplication
totheearliestperiodpresented,ifpracticable.The
29. (c)Therequirementistoidentifythe
circumstancesthatmayjustifyavoluntarychange
inaccountingmethod.Answer(c)iscorrect
becausethenewmethodmustprovidereliable
andmorerelevantinformation.
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
290
SOLUTIONSTOSIMULATIONS
TaskBasedSimulation1
Authoritative
Literature
Accountin
g
Changes
Help
ListA
Treatmen
t
(A)(B)(C)
(D)
ListB
Approac
h
(X)(Y)
(Z)
1.
Quomanufacturesheavyequipmenttocustomerspecificationsonacontractbasis.Onthe
basisthatitispreferable,accountingfortheselongtermcontractswasswitchedfromthe
completedcontractmethodtothepercentageofcompletionmethod.
2.
Asaresultofaproductionbreakthrough,Quodeterminedthatmanufacturingequipment
previouslydepreciatedoverfifteenyearsshouldbedepreciatedovertwentyyears.
3.
4.
QuochangedfromLIFOtoFIFOtoaccountforitsfinishedgoodsinventory.
5.QuochangedfromFIFOtoaveragecosttoaccountforitsrawmaterialsandworkinprocess
inventories.
9.
6.
Quosellsextendedservicecontractsonitsproducts.Becauserelatedservicesare
performedoverseveralyears,in2011Quochangedfromthecashmethodtothe
accrualmethodofrecognizingincomefromtheseservicecontracts.
7.
During2011,Quodeterminedthataninsurancepremiumpaidandentirely
expensedin2010wasfortheperiodJanuary1,2010,throughJanuary1,2012.
8.
Quochangeditsmethodofdepreciatingofficeequipmentfromanaccelerated
methodtothestraightlinemethodtomorecloselyreflectcostsinlateryears.
Quoinstitutedapensionplanforallemployeesin2011andadoptedtheaccountingstandards
relatedtopensions.Quohadnotpreviouslyhadapensionplan.
10. During2011,QuoincreaseditsinvestmentinWorth,Inc.froma10%interest,purchasedin
2010,to30%,andacquiredaseatonWorthsboardofdirectors.Asaresultofitsincreased
investment,Quochangeditsmethodofaccountingforinvestmentinsubsidiaryfromthe
costadjustedforfairvaluemethodtotheequitymethod.
Explanationofsolutions
3.
1.
(A, X) This situation represents a change in the method of accounting for longterm
constructiontype contracts and requires retrospective application for all periods
presented.
2.
(B,Z)Thissituationisnotachangeinaccountingprinciplebutisachangeinanestimate
andshouldbehandledprospectively.
(B,Z)Thissituationisachangeinanestimate.Thechangeinthepercentageofwarrantycostsisnota
changeinaccountingprinciple.Changesinestimatearehandledprospectively.
4.
5.
(A,X)Thissituationisachangefromoneacceptableaccountingmethodtoanother
andrequirestheretrospectiveapplicationapproach.
6.
(C,Y)Theuseofthecashmethodisconsideredanerrorsincethatmethodisgenerallynot
acceptable.Theswitchtoanacceptablemethod(accrual)isconsideredthecorrectionofan
errorandrequirestheretroactiverestatementapproach.
7.
(C,Y)Thewriteoffoftheinsurancepremiumwasanerror.Sincecomparativefinancial
statementsareprepared,pastyearsmustbecorrectedusingtheretroactiverestatement
approacheventhoughthiserrorisselfcorrectingaftertwoyears.
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
291
8.
(B,Z)Thissituationisachangeinmethodwhichisconsideredachangeinestimateeffected
by a change in principle. Per SFAS 154, a change in depreciation method requires
prospectiveapplication.
9.
(D,Z)Sincethecompanydidnotpreviouslyaccountforpensionsthissituationissimply
theadoptionofanappropriateaccountingprincipleforpensions.Nochangeinprinciple
occurs.
10. (D,Y)Quosincreaseinownershipinterest(10%to30%)anditsacquisitionofaseaton
WorthsboardofdirectorshasgivenQuotheabilitytoexercisesignificantinfluenceinthe
operatingdecisionsofWorth.IfQuodoesnotelecttousethefairvalueoptiontoreportits
30%investmentinWorth,Quowillusetheequitymethodtoaccountforitsinvestmentin
Worth.Thecostadjustedforfairvaluemethodisnolongerapplicableduetothechangein
QuosinvestmentinWorth.However,thechangefromthecostadjustedforfairvalue
methodtotheequitymethodisnotachangeinaccountingprinciple.Achangeinaccounting
principleoccurswhenanaccountingprincipledifferentfromtheoneusedpreviouslyfor
reportingpurposesisadopted.Forachangetooccur,achoicebetweentwoormore
accountingprinciplesmustexist.Inthiscase,thechangeinQuossituationallowstheequity
methodtoaccountfortheinvestment.Quoscurrenteconomicsituationisclearlydifferent
andthisnecessitatestheadoptionofadifferentaccountingprinciple.Consequently,thisis
notanaccountingchange.However,theinvestmentaccountshouldberetroactivelyrestated
toreflectbalancesasiftheequitymethodhadalwaysbeenused.
TaskBasedSimulation2
Calculations
Authoritative
Literature
Help
1. Accumulateddepreciationasof12/31/10
$180,000
2. Depreciationexpensefor2011
$ 40,000
3. Accumulateddepreciationasof12/31/11
$220,000
4. Indicatetheamountoftheaccountingchangeshownnetoftaxifappropriate
Explanationofsolutions
1.Beforechange,Kentuseddoubledecliningbalanceand10yearlife
2009
2010
1/102 $500,000bookvalue
1/102 $400,000newbookvalue
Accumulateddepreciation12/31/09
=
=
$100,000 depreciationexpense
$80,000 depreciationexpense
$180,000
2.Tocalculatedepreciationexpensefor2011:
Historicalcost
Accum.depreciation
Bookvalue
$500,000
(180,000)
$320,000
($320,000$0salvage)8yearsremaininglife=$40,000depreciationexpense
3.Tocalculateaccumulateddepreciationasof12/31/11:
2009
2010
2011
Accum.depr.12/31/11
$100,000
80,000
40,000
$220,000
4.Accountingchangenetoftaxzero.Accountingstandardstreatchangesindepreciation
methodasachangeinestimateeffectedbyachangeinmethod.Therefore,achangein
depreciationisaccountedforonaprospectivebasis.
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
292
TaskBasedSimulation3
Classification/
Disclosure
1.
Changeitem
Clarkchangeditsdepreciation
methodforitsproduction
machineryfromthedouble
decliningbalancemethodtothe
straightlinemethodeffective
January1,2011.
2. Clarkappropriatelychanged
thesalvagevaluesusedin
computingdepreciationfor
itsofficeequipment.
3.
Clarkappropriatelychangedthe
specificsubsidiariesconstituting
thegroupofcompaniesforwhich
consolidatedfinancialstatements
arepresented.
Explanationofsolutions
Authoritative
Literature
Help
Cumulativeeffectof
changeinprinciple
innetincomeofthe
periodofchange
Yes
No
3.
Proformaeffectsof
retroactiveapplication
forallpriorperiods
presentedcurrently
Yes
No
Retrospective
applicationtofinancial
statementsofallprior
periodspresented
currently
Yes
No
1.
2.
(N,N,N)Clarkschangeinsalvagevaluesisachangeinaccountingestimate.Clarkwould
not report a cumulative effect, nor pro forma effects, nor would prior period financial
statementsberestated.
(N,N,Y)Clarkschangeinthespecificsubsidiariesconstitutingthegroupofcompaniesforwhich
consolidatedfinancialstatementsarepresentedisachangeinreportingentity.Thechangeinreporting
entityrequiresthechangetoberetrospectivelyappliedtothefinancialstatementsofallpriorperiods
presentedtoshowfinancialinformationforthenewreportingentity.
TaskBasedSimulation4
Research
Authoritative
Literature
ASC
250
10
45
Help
18
TaskBasedSimulation5
Accounting
Treatment
Authoritative
Literature
1.
Help
Falkmanufacturescustomizedequipmentto
customerspecificationsonacontractbasis.Falk
changeditsmethodofaccountingfortheselong
termcontractsfromthecompletedcontractmethod
tothepercentageofcompletionmethodbecause
Falkisnowabletomakereasonableestimatesof
futureconstructioncosts.
2. Basedonimprovedcollectionprocedures,Falk
changedthepercentageofcreditsalesusedto
determinetheallowanceforuncollectible
accountsfrom2%to1%.
ListA
TypeofChange
(A)(B)(C)(D)
ListB
AccountingTreatment
(X)(Y)(Z)
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
Explanationofsolutions
1.
2.
(B,Z)Thepercentageofnetcreditsalesusedindeterminingtheamounttobeaddedtothe
allowanceforuncollectibleaccountsisanestimatemadebymanagement.Changingthe
percentageisachangeinaccountingestimate,whichistreatedprospectively.
TaskBasedSimulation6
Accounting
Change
Authoritative
Literature
Help
PoseyCorporation
INCOMESTATEMENT
Sales
Costofgoodssold
Grossprofit
Operatingexpenses
Earningsbeforetaxes
Incometaxexpense(40%)
Netincome
Adjusted
fortheyearending123111
$130,000
87,000
43,000
20,000
23,000
9,200
13,800
December31,2011
$14,000
10,000
Inventory
Incometaxliability
Adjusted
fortheyearending123110
$100,000
68,000
32,000
17,000
15,000
6,000
9,000
December31,2010
$7,000
6,000
Explanationofsolutions
TocalculatecostofgoodssoldusingFIFOmethod,youmustfirstcalculatepurchasesusing
theaveragecostmethod.UsingTaccountsforanalysis,theamountsareasshownbelow.
1110
Purchases
123110
Purchases
123111
Inventory
(Weightedaveragemethod)
0
70,000
75,000
5,000
90,000
94,000
CGS
9,000
Inventory
(FIFOmethod)
1110
Purchases
123110
0
75,000
7,000
Purchases
94,000
123111
14,000
IncometaxliabilityforDecember31,2011,iscalculatedas
2011earningsbeforetaxes23,00040%=
2010adjustmenttoearningsbeforetaxes2,00040%
CGS
$9,200
+800
68,000
CGS
87,000
CGS
293
Totalincometaxliabilityat123111
$10,000
MODULE9BASICTH.&FIN.REP.:C.ACCOUNTINGCHANGES
294
TaskBasedSimulation7
Research
ASC
250
Authoritative
Literature
Help
10
45
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
295
FINANCIALSTATEMENTS
MULTIPLECHOICEQUESTIONS(1114)
1.InBaerFoodCo.s2010singlestepincome
statement,thesectiontitledRevenues
consistedofthefollowing:
Netsalesrevenue
Resultsfromdiscontinuedoperations:
LossfromdiscontinuedcomponentZin
cludinglossondisposalof$1,200
Lesstaxbenefit
3. WhatamountshouldVanereportasincomeafterin
cometaxesfromcontinuingoperations?
a.
$126,000
b.
$129,500
c.
$140,000
d.
$147,000
$16,400
4,000
Interestrevenue
Gainonsaleofequipment
Extraordinarygain
Totalrevenues
a.
b.
c.
d.
Intherevenuessectionofthe2010income
statement,BaerFoodshouldhavereported
totalrevenuesof
$216,300
$215,400
$203,700
$201,900
Items2and3arebasedonthefollowing:
VaneCo.strialbalanceofincomestatement
accountsfortheyearendedDecember31,
2011,includedthefollowing:
Sales
Costofsales
Administrativeexpenses
Lossonsaleofequipment
Salescommissions
Interestrevenue
Freightout
Lossonearlyretirementoflongtermdebt
Uncollectibleaccountsexpense
Totals
Otherinformation
Finishedgoodsinventory:
January1,2011
December31,2011
Debit
$240,000
70,000
10,000
50,000
15,000
20,000
15,000
$420,000
$400,000
360,000
Vanesincometaxrateis30%.InVanes
2011multiplestepincomestatement,
2. WhatamountshouldVanereportasthecostofgoods
manufactured?
a.
$200,000
b.
$215,000
c.
$280,000
d.
$295,000
Onehalfoftherentedpremisesisoccupied
bythesalesdepartment.
Brockstotalsellingexpensesfor2010are
a. $480,000
b. $400,000
c. $370,000
d. $360,000
7.InYewCo.s2010annualreport,Yew
describeditssocialawarenessexpenditures
duringtheyearasfollows:
TheCompanycontributed$250,000incashto
youthandeducationalprograms.TheCompany
alsogave$140,000tohealthandhumanservice
organizations,ofwhich$80,000wascontributed
byemployeesthroughpayrolldeductions.In
addition,consistentwiththeCompanys
commitmenttotheenvironment,theCompany
spent$100,000toredesignproductpackaging.
5.Thefollowingcostswereincurredby
GriffCo.,amanufacturer,during2010:
Accountingandlegalfees
Freightin
Freightout
Officerssalaries
Insurance
Salesrepresentativessalaries
$25,000
175,000
160,000
150,000
85,000
215,000
Whatamountoftheaboveshouldbe
includedinYewsincomestatementas
charitablecontributionsexpense?
Whatamountofthesecostsshouldbe
reportedasgeneralandadministrative
expensesfor2010?
a. $260,000
b. $550,000
c. $635,000
d. $810,000
a.
b.
c.
d.
$310,000
$390,000
$410,000
$490,000
8.
During2010bothRaimCo.andCane
Co.sufferedlossesduetotheflooding
oftheMississippiRiver.Raimis
locatedtwomilesfromtheriverand
sustainsfloodlosseseverytwoto
threeyears.Cane,whichhasbeen
locatedfiftymilesfromtheriverfor
thepasttwentyyears,hasnever
beforehadfloodlosses.Howshould
thefloodlossesbereportedineach
companys2010incomestatement?
6.Whichofthefollowingshouldbeincluded
ingeneralandadministrativeexpenses?
a.
b.
c.
d.
Interest
Yes
Yes
No
No
Advertising
Yes
No
Yes
No
4. BrockCorp.reportsoperatingexpensesin
twocatego
ries:(1)selling,and(2)generaland
administrative.The
adjustedtrialbalanceatDecember31,2010,
includedthe
followingexpenseandlossaccounts:
Accountingandlegalfees
Advertising
Freightout
Interest
Lossonsaleoflongterminvestment
Officerssalaries
Rentforofficespace
Salessalariesandcommissions
$120,000
150,000
80,000
70,000
30,000
225,000
220,000
140,000
Raim
a. Asacomponent
ofincomefrom
continuing
operations
b. Asacomponent
ofincomefrom
continuing
operations
c. As
an
extraordinary
item
d.
As
extraordinary
item
Cane
Asanextraordinary
item
Asacomponentof
incomefrom
continuingopera
tions
Asacomponentof
incomefrom
continuingopera
tions
Asanextraordinary
an item
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
296
12. OceanCorp.scomprehensive
insurancepolicyallowsitsassetsto
bereplacedatcurrentvalue.The
policyhasa$50,000deductible
clause.OneofOceanswaterfront
warehouseswasdestroyedina
winterstorm.Suchstormsoccur
approximatelyeveryfouryears.
Oceanincurred$20,000ofcostsin
dismantlingthewarehouseandplans
toreplaceit.Thefollowingdata
relatetothewarehouse:
9.WittCo.incurredthefollowinginfrequent
lossesduring2010:
$150,000fromanearthquake(unusual).
$125,000 from the abandonment of
equipmentusedinthebusiness.
a.
b.
c.
d.
InWitts2010incomestatement,thetotal
amountofinfrequentlossesnotconsidered
extraordinaryshouldbe
$275,000
$300,000
$325,000
$450,000
10.KentCo.incurredthefollowinginfrequent
lossesduring2010:
A$300,000losswasincurredondisposal
ofoneoffourdissimilarfactories.
Amajorcurrencydevaluationcauseda
$120,000 exchange loss on an
amount remitted by a foreign cus
tomer.
Inventoryvaluedat$190,000wasmade
worthlessbyacompetitorsunexpected
productinnovation.
Inits2010incomestatement,whatamount
shouldKentreportaslossesthatarenot
consideredextraordinary?
a. $610,000
b. $490,000
c. $420,000
d. $310,000
11. Midway Co. had the following
transactionsduring2010:
$1,200,000
pretax loss on
foreign currency
exchangeduetoa
majorunexpected
devaluation by
the foreign
government.
$500,000 pretax
loss
from
discontinued
operations of a
division.
$800,000pretaxlossonequipment
damagedbyahurricane.Thiswasthefirst
hurricaneevertostrikeinMidwaysarea.
Midwayalsoreceived$1,000,000fromits
insurancecompanytoreplaceabuilding,
withacarryingvalueof$300,000,thathad
beendestroyedbythehurricane.
WhatamountshouldMidwayreportinits
2010incomestatementasextraordinaryloss
beforeincometaxes?
a.
b.
c.
d.
$100,000
$1,300,000
$1,800,000
$2,500,000
Currentcarryingamount
Replacementcost
WhatamountofgainshouldOceanreportas
aseparatecomponentofincomebefore
extraordinaryitems?
a.
b.
c.
d.
$1,030,000
$780,000
$730,000
$0
$300,000
1,100,000
13.PurlCorporationsincomestatementforthe
yearendedDecember31,2010,showsthe
following:
Incomebeforeincometaxandextraordinaryitem
Gainonlifeinsurancecoverageincludedinthe
above$900,000incomeamount
Extraordinaryitemlossduetoearthquakedamage
Purlstaxratefor2010is40%.Howmuch
shouldbereportedastheprovisionforincome
taxinPurls2010incomestatement?
a. $200,000
b. $240,000
c. $320,000
d. $360,000
Shouldthesegainsbeincludedincontinuing
operationsorreportedasanextraordinary
iteminPegs2010incomestatement?
14. ThorpeCo.sincomestatementfor
theyearendedDecember31,2011,
reportednetincomeof$74,100.The
auditorraisedquestionsaboutthe
followingamountsthathadbeen
includedinnetincome:
Unrealizedlossondeclineinmarketvalueof
noncurrentinvestmentsinstockclassifiedas
availableforsale(netoftax)
Gainonearlyretirementofbondspayable(netof
$11,000taxeffect)
Adjustmenttoprofitsofprioryearsforerrorsin
depreciation(netof$3,750taxeffect)
Lossfromfire(netof$7,000taxeffect)
Thelossfromthefirewasaninfrequentbutnot
unusualoccurrenceinThorpeslineofbusiness.
ThorpesDecember31,2011incomestatement
shouldreportnetincomeof
a.
b.
c.
d.
$65,000
$66,100
$81,600
$87,000
administrative
expenses.
c. Allofthecabinetcostsincostofgood
sold.
d. All of the cabinet costs in
selling, general, and ad
ministrativeexpenses.
16. Amateriallossshouldbepresented
separatelyasacomponentofincome
fromcontinuingoperationswhenitis
a.
b.
c.
d.
Anextraordinaryitem.
A discontinued component of the
business.
Unusual in nature and infrequent in
occurrence.
Notunusualinnaturebutinfrequentin
occurrence.
$(5,400)
(14,000)
a.
b.
c.
d.
Gainfrommajor
currencyrevaluation
Continuingoperations
Extraordinaryitem
Extraordinaryitem
Continuingoperations
Gainfromincrease
incontractsprice
Continuingoperations
Continuingoperations
Extraordinaryitem
Extraordinaryitem
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
18.Anextraordinaryitemshouldbereported
separatelyontheincomestatementasa
componentofincome
a.
b.
c.
d.
Netofincometaxes
Yes
Yes
No
No
Beforediscontinuedoperations
ofacomponentofabusiness
Yes
No
No
Yes
19. In2010,haildamagedseveralofToncanCo.s
vans.Hailstormshadfrequentlyinflictedsimilar
damagetoToncansvans.Overtheyears,
Toncanhadsavedmoneybynotbuyinghail
insuranceandeitherpayingforrepairs,orselling
damagedvansandthenreplacingthem.In2010,
thedamagedvansweresoldforlessthantheir
carryingamount.Howshouldthehaildamage
costbereportedinToncans2010financial
statements?
a. The actual 2010 hail
damage loss as an
extraordinary loss, net of
incometaxes.
b. Theactual2010haildamage
loss in continuing op
erations, with no separate
disclosure.
c.
d.
20. Atransactionthatisunusualinnature
and infrequent in occurrence should
bereportedseparatelyasacomponent
ofincome
a. After cumulative effect of
accounting changes and
before
discontinued
operations.
b. After cumulative effect of
accountingchangesandafter
discontinuedoperations.
c. Before cumulative effect
of accounting changes
and before discontinued
operations.
d. Before cumulative effect
of accounting changes
and after discontinued
operations.
21. In2010,TellerCo.incurredlosses
arisingfromitsguiltypleainitsfirst
antitrustaction,andfromasubstantial
297
increaseinproductioncostscaused
whenamajorsuppliersworkerswent
onstrike.Whichoftheselosses
shouldbereportedasan
extraordinaryitem?
a.
b.
c.
d.
Antitrustaction
No
No
Yes
Yes
Productioncosts
No
Yes
No
Yes
22.Inopenmarkettransactions,GoldCorp.
simultaneouslysolditslongterminvestmentin
IronCorp.bondsandpurchaseditsown
outstandingbonds.Thebrokerremittedthenet
cashfromthetwotransactions.Goldsgainon
thepurchaseofitsownbondsexceededitsloss
onthesaleoftheIronbonds.Goldshould
reportthe
a. Neteffectofthetwotransactionsas
anextraordinarygain.
b. Neteffectofthetwotransactionsin
incomebeforeextraordinaryitems.
c. Effectofitsownbondtransaction
gaininincomebeforeextraordinary
items,andreporttheIronbond
transactionasalossinincome
beforeextraordinaryitems.
d. Effectofitsownbondtransactionas
anextraordinarygain,andreportthe
Ironbondtransactionlossinincome
beforeextraordinaryitems.
d.
reported as an
extraordinaryloss.
$500,000shouldbereported
as revenues from op
erations of a discontinued
component.
26. Whichofthefollowingcriteriaisnot
requiredforacomponentsresultsto
beclassifiedasdiscontinuedopera
tions?
a. Management must have
entered into a sales agree
ment.
b. The component is available for
immediatesale.
c. Theoperationsandcash
flowsofthecomponentwill
beeliminatedfromthe
operationsoftheentityasa
resultofthedisposal.
d. Theentitywillnothaveany
significantcontinuing
involvementinthe
operationsofthecomponent
afterdisposal.
27. OnNovember1,2010,management
ofHerronCorporationcommittedto
aplantodisposeofTimmsCompany,
amajorsubsidiary.Thedisposal
meetstherequirementsfor
classificationasdiscontinued
operations.Thecarryingvalueof
TimmsCompanywas$8,000,000and
managementestimatedthefairvalue
lesscoststoselltobe$6,500,000.For
2010,TimmsCompanyhadalossof
$2,000,000.HowmuchshouldHerron
Corporationpresentaslossfromdis
continuedoperationsbeforetheeffect
oftaxesinitsincomestatementfor
2010?
a. $0
b. $1,500,000
c. $2,000,000
d. $3,500,000
298
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
d.
28. OnDecember1,2010,GreerCo.committedtoa
plantodisposeofitsHartbusinesscomponents
assets.Thedisposalmeetstherequirementsto
beclassifiedasdiscontinuedoperations.Onthat
date,Greerestimatedthatthelossfromthe
dispositionoftheassetswouldbe$700,000and
Harts2010operatinglosseswere$200,000.
Disregardingincometaxes,whatnetgain(loss)
shouldbereportedfordiscontinuedoperations
inGreers2010incomestatement?
a. $0
b. $(200,000)
c. $(700,000)
d. $(900,000)
29. A component of Ace, Inc. was
discontinued during 2011. Aces
lossondisposalshould
a. Exclude the associated employee
relocationcosts.
b. Exclude operating losses for the
period.
c. Include associated employee
terminationcosts.
d. Exclude associated lease cancellation
costs.
30. Whenacomponentofabusinesshas
beendiscontinuedduringtheyear,this
componentsoperatinglossesofthe
currentperiodshouldbeincludedin
the
a. Income statement as
part of revenues and
expenses.
b. Incomestatementaspartof
the loss on disposal of the
discontinuedcomponent.
c. Incomestatementaspartof
the income (loss) from
continuingoperations.
d. Retained earnings statement
as a direct decrease in
retainedearnings.
31. Whenacomponentofabusinesshas
beendiscontinuedduringtheyear,the
lossondisposalshould
a. Includeoperatinglossesofthecurrent
period.
b. Exclude operating losses during the
period.
c. Beanextraordinaryitem.
d. Beanoperatingitem.
32. OnJanuary1,2011,ShineCo.agreed
tosellabusinesscomponenton
March1,2011.Thegainonthe
disposalshouldbe
a. Presentedasanextraordinarygain.
b. Presentedasanadjustmenttoretained
earnings.
c. Netted with the loss from
operationsofthecomponent
as a part of discontinued
operations.
Noneoftheabove.
with
owners.
b. To report a measure of
overall enterprise perfor
mance.
c. To replace net income with a better
measure.
d. Tocombineincomefrom
continuingoperationswith
incomefromdiscontinued
operationsandex
traordinaryitems.
34. During2010,theotherrevenuesand
gainssectionofTotmanCompanys
StatementofEarningsand
ComprehensiveIncomecontains
$5,000ininterestrevenue,$15,000
equityinHarpoCo.earnings,and
$25,000gainonsaleofavailablefor
salesecurities.Assumingthesaleof
thesecuritiesincreasedthecurrent
portionofincometaxexpenseby
$10,000,determinetheamountof
Totmansreclassificationadjustment
toothercomprehensiveincome.
a.
b.
c.
d.
$5,000
$2,500
$35,000
$15,000
35. Whichofthefollowingisnotan
acceptableoptionofreportingother
comprehensiveincomeandits
components?
a.
c.
d.
In a separate statement of
comprehensiveincome.
b. Inastatementofearnings
and comprehensive in
come.
Inthefootnotes.
In a statement of changes in
stockholdersequity.
asavailableforsale.Thecompany
doesnotelecttousethefairvalue
optionforreportingitsavailablefor
salesecurities.Thefairvalueofthe
securitiesincreasesto$2,500on
December31,2009,andto$2,750on
December31,2010.OnDecember31,
2010,thecompanysellsthesecurities.
Assumenodividendsarepaidand
thatthecompanyhasataxrateof
30%.Whatistheamountofthe
reclassificationadjustmentforother
comprehensiveincomeonDecem
ber31,2010?
a. $7,500
b. $(7,500)
c. $5,250
d. $(5,250)
Retainedearnings
No
Yes
Additionalpaidincapital
Yes
Yes
c.
d.
Yes
No
No
No
39. Acompanybuystensharesof
securitiesat$1,000eachonJanuary
15,2010.Thesecuritiesareclassified
asavailableforsale.Thefairvalueof
thesecuritiesincreasesto$1,250per
shareasofDecember31,2010.The
companydoesnotelecttousethefair
valueoptionforreportingavailable
forsalesecurities.Assumeno
dividendsarepaidandthatthe
companyhasa30%taxrate.Whatis
theamountoftheholdinggainarising
duringtheperiodthatisclassifiedin
othercomprehensiveincomeforthe
periodendingDecember31,2010?
a. 0
b. $1,750
c. $2,500
d. $7,500
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
PensionliabilityadjustmentrecognizedinOCI
Unrealizedgainonavailableforsalesecurities
Reclassificationadjustment,forsecuritiesgain
includedinnetincome
Stockwarrantsoutstanding
Netincome
a.
b.
c.
d.
$(3,000)
$86,500
$89,000
$89,500
$90,500
41. If($2,450)netoftaxisthe
reclassificationadjustmentincluded
inothercomprehensiveincomein
theyearthesecuritiesaresold,what
isthegain(loss)thatisincludedin
incomefromcontinuingoperations
beforeincometaxes?Assumea30%
taxrate.
a. $(2,450)
b. $(3,500)
c. $2,450
d. $3,500
42. Whichofthefollowingchangesduring
aperiodis not acomponentofother
comprehensiveincome?
a. Pensio
n
liability
adjust
ment
for
funded
status
ofplan.
b. Treasurystock,atcost.
c. Foreign currency translation
adjustment.
d. Reclassifi
cation
adjustme
nt, for
securities
gain in
cluded in
net
income.
43. Whichofthefollowingistrue?
a. Separate
EPS
amounts
mustbe
presented
forboth
other
compreh
ensive
income
and
compreh
ensive
income.
b. Separate
EPS
c.
299
amounts
must be
presented
for other
comprehe
nsive
income
but not
for
comprehe
nsive
income.
Separate EPS amounts must be
presented for comprehensive income
but not for other comprehensive
income.
d. Separat
e EPS
amounts
are not
required
to be
pre
sented
for
either
other
compre
hensive
income
or
compre
hensive
income.
Acontinuationfromnet
incomeatthebottomof
theincomestatement.
II.Aseparatestatementthatbeginswith
netincome.III.Inthestatementof
changesinstockholdersequity.
a.
b.
c.
d.
I.
II.
IIandIII.
IandII.
45. Assumeacompanydoesnotelectthe
fairvalueoptionforreportingfinancial
assetsandliabilities.Whichofthe
followingisnotclassifiedasother
comprehensiveincome?
a.
An
adjust
ment
to
pensio
n
liabilit
y to
record
the
funde
d
status
b.
d.
of the
plan.
Subsequentdecreasesofthefairvalue
ofavailableforsalesecuritiesthat
havebeenpreviouslywrittendownas
impaired.
c. Decrease
s in the
fair
value of
heldto
maturity
se
curities.
Noneoftheabove.
46.Whenafullsetofgeneralpurposefinancial
statementsarepresented,comprehensive
incomeanditscomponentsshould
a. Appearasapartofdiscontinued
operations,extraordinaryitems,
andcumulativeeffectofachange
inaccountingprinciple.
b. Bereportednetofrelatedincometax
effect,intotalandindividually.
c. Appearinasupplementalschedulein
thenotestothefinancialstatements.
d.
Bedisplayedinafinancialstatement
thathasthesameprominenceasother
financialstatements.
Items47through49arebasedonthe
following:
ThefollowingtrialbalanceofMintCorp.at
December31,2010,hasbeenadjustedexceptfor
incometaxexpense.
Cash
Accountsreceivable,net
Costinexcessofbillingsonlong
termcontracts
Billingsinexcessofcostsonlong
termcontracts
Prepaidtaxes
Property,plant,andequipment,net
Notepayablenoncurrent
Commonstock
Additionalpaidincapital
Retainedearningsunappropriated
Retainedearningsrestrictedfor
notepayable
Earningsfromlongtermcontracts
Costsandexpenses
Dr.
600,000
3,500,000
1,600,000
450,000
1,480,000
Mintusesthepercentageof
completionmethodtoaccountfor
longtermconstructioncontractsfor
financialstatementandincometax
purposes.Allreceivablesonthese
contractsareconsideredtobe
collectiblewithintwelvemonths.
During2010,estimatedtaxpaymentsof
$450,000werechargedtoprepaidtaxes.
Minthasnotrecordedincometax
expense.Therewerenotemporaryor
permanentdifferences,andMintstax
rateis30%.
InMintsDecember31,2010balancesheet,
whatamountshouldbereportedas
48. Totalnoncurrentliabilities?
a. $1,620,000
b. $1,780,000
c. $2,320,000
d. $2,480,000
49. Totalcurrentassets?
700,000
1,620,000
750,000
2,000,000
900,000
160,000
6,680,000
5,180,000
$12,810,000 $12,810,000
Otherfinancialdatafortheyearended
December31,2010,are
47. Totalretainedearnings?
a. $1,950,000
b. $2,110,000
c. $2,400,000
d. $2,560,000
Cr.
a.
b.
c.
d.
$5,000,000
$5,450,000
$5,700,000
$6,150,000
300
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
rowedfundsof$110,000.Duringthefirstyear
ofoperations,revenuesfromsalesand
consultingamountedto$82,000,andoperating
costsandexpensestotaled$64,000.On
December15,Mirrdeclareda$3,000cash
dividend,payabletostockholdersonJanuary
15,2011.Noadditionalactivitiesaffected
ownersequityin2010.Mirrsliabilities
increasedto$120,000byDecember31,2010.
OnMirrsDecember31,2010balancesheet,
totalassetsshouldbereportedat
a. $885,000
b. $882,000
c. $878,000
d. $875,000
51. ThefollowingchangesinVelCorp.saccount
balancesoccurredduring2010:
55.DeanCo.acquired100%ofMoreyCorp.
priorto2010.During2010,theindividual
companiesincludedintheirfinancialstatements
thefollowing:
Officerssalaries
Officersexpenses
Loanstoofficers
Intercompanysales
a.
b.
c.
d.
Dean
$75,000
20,000
125,000
150,000
Whatamountshouldbereportedasrelated
partydisclosuresinthenotestoDeans2010
consolidatedfinancialstatements?
$150,000
$155,000
$175,000
$330,000
Morey
$50,000
10,000
50,000
Assets
Liabilities
Capitalstock
Additionalpaidincapital
Increase
$89,000
27,000
60,000
6,000
Exceptfora$13,000dividendpaymentandtheyearsearnings,therewerenochangesinretained
earningsfor2010.WhatwasVelsnetincomefor2010?
a. $4,000
b. $9,000
c. $13,000
d. $17,000
52. Whenpreparingadraftofits2010balancesheet,Mont,Inc.reportednetassetstotaling
$875,000.Includedintheassetsectionofthebalancesheetwerethefollowing:
TreasurystockofMont,Inc.atcost,whichapproxi
matesmarketvalueonDecember31
Idlemachinery
Cashsurrendervalueoflifeinsuranceoncorporate
executives
Allowancefordeclineinmarketvalueofnoncurrent
equityinvestments
$24,000
11,200
13,700
8,400
AtwhatamountshouldMontsnetassetsbereportedintheDecember31,2010balancesheet?
a. $851,000
b. $850,100
c. $842,600
d. $834,500
53. Inanalyzingacompanysfinancialstatements,whichfinancialstatementwouldapotential
investorprimarilyusetoassessthecompanysliquidityandfinancialflexibility?
a.
b.
c.
d.
Balancesheet.
Incomestatement.
Statementofretainedearnings.
Statementofcashflows.
54. During2010,JonesCompanyengagedinthefollowingtransactions:
Salaryexpensetokeyemployeeswhoarealso
principalowners
Salestoaffiliatedenterprises
a.
b.
c.
d.
$100,000
250,000
WhichofthetwotransactionswouldbedisclosedasrelatedpartytransactionsinJones2010financial
statements?
Neithertransaction.
The$100,000transactiononly.
The$250,000transactiononly.
Bothtransactions.
56. Whichtypeofmaterialrelatedpartytransactionrequiresdisclosure?
a. Onlythosenotreportedinthebodyofthefinancialstatements.
b. Onlythosethatreceiveaccountingrecognition.
c. Thosethatcontainpossibleillegalacts.
d. Allthoseotherthancompensationarrangements,expenseallowances,and
othersimilaritemsintheordinarycourseofbusiness.
57. Financial statements shall include disclosures of material transactions between related
partiesexcept
a. Nonmonetaryexchangesbyaffiliates.
b. Salesofinventorybyasubsidiarytoitsparent.
c. Expense allowance for executives which exceed normal business
practice.
d. Acompanysagreementtoactassuretyforaloantoitschiefexecutive
officer.
58. DexCo.hasenteredintoajointventurewithanaffiliatetosecureaccesstoadditionalinventory.Under
thejointventureagreement,Dexwillpurchasetheoutputoftheventureatpricesnegotiatedonan
armslengthbasis.
Whichofthefollowingis(are)requiredtobedisclosedabouttherelatedpartytransaction?
I.
a.
b.
Ionly.
IIonly.
Theamountduetotheaffiliateatthebalancesheetdate.II.Thedollaramountofthe
purchasesduringtheyear.
c.
d.
BothIandII.
NeitherInorII.
59. Whatisthepurposeofinformationpresentedinnotestothefinancialstatements?
a. To provide disclosures required by generally accepted accounting
principles.
b. Tocorrectimproperpresentationinthefinancialstatements.
c. To provide recognition of amounts not included in the totals of the
financialstatements.
d. Topresentmanagementsresponsestoauditorcomments.
60. WhichofthefollowinginformationshouldbeincludedinMelay,Inc.s2010summaryof
significantaccountingpolicies?
a. Property,plant,andequipmentisrecordedatcostwithdepreciation
computedprincipallybythestraightlinemethod.
b. During2010,theDelaycomponentwassold.
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
Business component 2010 sales are Alay $1M, Be 66. Which of the following describes a
principalmarketfor
lay$2M,andCelay$3M.
issued,Colterlost$250,000of
inventoryduetoafire.Theinventory
d. Future common share
wasatotallossandwasuninsured.
dividendsareexpectedto
HowshouldColterpresentthis
approximate 60% of
informationinitsDecember31,2010
earnings.
financialstatements?
61. Which of the following information
a. Colter should disclose the
shouldbedisclosedinthesummaryof
loss in a footnote to its
significantaccountingpolicies?
2010financialstatements.
a. Refinancing of debt
b. Colter should report an
subsequent to the
extraordinary loss in its
balancesheetdate.
2010incomestatement.
b. Guaranteesofindebtednessofothers.
c. Colter should
c. Criteria for determining
reportanallowance
which investments are
forlostinventoryin
treated as cash
its 2010 balance
equivalents.
sheet.
d. Adequacy of pension plan
d. Coltershouldnotreporttheloss.
assets relative to vested
64. Which of the following is a true
benefits.
statementregardingdisclosuresfor
62. SwiftCorp.preparesitsfinancialstatementsfor
subsequentevents?
itsfiscalyearendingDecember31,2010.Swift
a. Recognizealossforall
estimatesthatitsproductwarrantyliabilityis
recognizedandunrecognized
$28,000atDecember31,2010.OnFebruary12,
subsequenteventsinthe
2011,beforethefinancialstatementswere
currentyearfinancial
issued,Swiftreceivedinformationabouta
statements.
productdefectthatwillrequirearecallofall
b. Recognizeagainor
unitssoldin2010.Itisexpectedtheproduct
lossforanyrecognized
recallwillcostanadditional$40,000in
subsequenteventinthe
warrantyrepairs.WhatshouldSwiftpresentin
currentyearfinancial
itsDecember31,2010financialstatements?
statements.
a. A footnote disclosure explaining the
c. Recognizealossforarecognized
productrecall.
subsequenteventinthefinancial
b. Afootnotedisclosurelisting
statementsintheyearwhenthe
the estimated amount of
subsequenteventoccurs.
$40,000inwarrantyrepairs
d. Recognize a loss for a recognized
and an explanation of the
subsequent event in the current year
recall.
financialstatements.
c. An estimated warranty liability of
65. Thefairvalueofanassetshouldbebased
$68,000.
upon
d. Nodisclosureisnecessary.
a. Thereplacementcostofanasset.
63. ColterCorp.hasafiscalyearendof
b. The price that would be
December31,2010.Onthatdate,
received to sell the asset at
Colterreportedtotalassetsof
themeasurementdate.
$600,000.OnMarch1,2011,before
c. The original cost of the
the2010financialstatementswere
asset plus an adjustment
c.
301
d.
forobsolescence.
Thepricethatwouldbepaidtoacquire
theasset.
establishingfairvalueofanasset?
a. The market that has the
greatest volume and level
ofactivityfortheasset.
b. Any broker or dealer
marketthatbuysorsellsthe
asset.
c. The most observable
market in which the price
oftheassetisminimized.
d. The market in which the amount
receivedwouldbemaximized.
67. Whichofthefollowingistruefor
valuinganassettofairvalue?
a. Thepriceoftheasset
shouldbeadjustedfor
transactioncosts.
b. Thefairvalueoftheasset
should be adjusted for
coststosell.
c. Thefairvaluepriceisbased
upon an entry price to
purchasetheasset.
d.
Thepriceshouldbeadjusted
fortransportationcoststo
transporttheassettoits
principalmarket.
a.
b.
c.
d.
A liquidation
market in which
sellers
are
compelledtosell.
Asubsidiaryofthe
reportingunitinterestedin
purchasingassetssimilar
tothosebeingvalued.
Anindependententitythatis
knowledgeable about the
asset.
A broker or dealer that
wishes to establish new
marketfortheasset.
a.
b.
c.
d.
Incomeapproach.
Residualvalueapproach.
Marketapproach.
Costapproach.
72. Valuationtechniquesforfair
valuethatincludetheBlack
ScholesMertonformula,a
binomialmodel,ordiscounted
cashflowsareexamplesofwhich
valuationtechnique?
a. Incomeapproach.
b. Marketapproach.
c. Costapproach.
d. Exitvalueapproach.
73. The market approach valuation technique for
measuring fair value requires which of the
following?
a. Presentvalueoffuturecashflows.
b.
Pricesandotherrelevant
informationoftransactions
fromidenticalor
comparableassets.
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
302
c.Thepricetoreplacetheservicecapacityofthe
asset.
d.Theweightedaverageofthepresentvalueof
futurecashflows.
74. A change in valuation techniques
usedtomeasurefairvalueshouldbe
reportedas
a. A
change
in
accoun
ting
princip
lewith
retrosp
ective
restate
ment.
b.
c.
d.
An error
correction
with
restatement
of the
financial
statements
of previous
periods.
A change in
accounting
estimate
reported on a
prospective
basis.
An extraordinary
itemonthecurrent
years income
statement.
a.
b.
c.
d.
Ionly.
IandIIonly.
IandIIIonly.
I,IIandIII.
77. Acompanythatwishestodisclose
informationabouttheeffectof
changingpricesshouldreportthis
informationin
a. Thebodyofthefinancialstatements.
b. Thenotestothefinancialstatements.
c. Supplementary
a.
b.
c.
d.
d.
$ 0
$ 20,000
$600,000
$ 620,000
informationtothe
financial state
ments.
Managementsreporttoshareholders.
78. LewisCompanywasformedon
January1,2009.Selectedbalances
fromthehistoricalcostbalancesheet
atDecember31,2010,wereas
follows:
Land(purchasedin2009)
Investmentinnonconvertiblebonds(purchasedin
2009,andexpectedtobeheldtomaturity)
Longtermdebt
$120,000
60,000
80,000
TheaverageConsumerPriceIndexwas100
for2009,and110for2010.Ina
supplementaryconstantdollarbalancesheet
(adjustedforchangingprices)atDecember
31,2010,theseselectedaccountbalances
shouldbeshownat
a.
b.
c.
d.
Land
$120,000
$120,000
$132,000
$132,000
Investment
$60,000
$66,000
$60,000
$66,000
Longtermdebt
$88,000
$88,000
$80,000
$80,000
79.Thefollowingitemswereamongthosethat
appearedonRubiCo.sbooksattheendof
2010:
Merchandiseinventory
Loanstoemployees
$600,000
20,000
WhatamountshouldRubiclassifyas
monetaryassetsinpreparingconstantdollar
financialstatements?
80.Initsfinancialstatements,HilaCo.
disclosessupplementalinformationonthe
effectsofchangingprices.Hilacomputedthe
increaseincurrentcostofinventoryasfol
lows:
Increaseincurrentcost(nominaldollars)
Increaseincurrentcost(constantdollars)
WhatamountshouldHiladiscloseasthe
inflationcomponentoftheincreasein
currentcostofinventories?
a. $3,000
b. $12,000
c. $15,000
d. $27,000
81. Whencomputingpurchasingpower
gainorlossonnetmonetaryitems,
whichofthefollowingaccountsis
classifiedasnonmonetary?
a. Advances to unconsolidated
subsidiaries.
b. Allowanceforuncollectibleaccounts.
c. Unamortized premium on bonds
payable.
d. Accumulated depreciation of
equipment.
82. Duringaperiodofinflationinwhicha
liability account balance remains
constant,whichofthefollowingoccurs?
a.
Apurchasingpowergain,iftheitemis
anonmonetaryliability.
b. Apurchasingpowergain,if
the item is a monetary
liability.
c. A purchasing power loss, if
the item is a nonmonetary
liability.
d.
Apurchasingpowerloss,if
the item is a monetary
liability.
83. Thefollowinginformationpertainsto
each unit of merchandise purchased
forresalebyVendCo.:
March1,2010
Purchaseprice
Sellingprice
Pricelevelindex
$8
$12
110
December31,2010
Replacementcost
Sellingprice
Pricelevelindex
$10
$15
121
Undercurrentcostaccounting,whatisthe
amountofVendsholdinggainoneachunitof
thismerchandise?
a. $0
b. $0.80
c. $1.20
d. $2.00
84. KerrCompanypurchasedamachine
for$115,000onJanuary1,2010,the
companysfirstdayofoperations.At
theendoftheyear,thecurrentcost
ofthemachinewas$125,000.The
machinehasnosalvagevalue,afive
yearlife,andisdepreciatedbythe
straightlinemethod.Fortheyear
endedDecember31,2010,the
amountofthecurrentcost
depreciationexpensewhichwould
appearinsupplementarycurrentcost
financialstatementsis
a. $14,000
b. $23,000
c. $24,000
d. $25,000
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
85.AtDecember31,2010,JannisCorp.owned
twoassetsasfollows:
Currentcost
Recoverableamount
a.
b.
c.
d.
Equipment
$100,000
$95,000
Inventory
$80,000
$90,000
Jannisvoluntarilydisclosedsupplementary
informationaboutcurrentcostatDecember
31,2010.Insuchadisclosure,atwhat
amountwouldJannisreporttotalassets?
$175,000
$180,000
$185,000
$190,000
86.Couldcurrentcostfinancialstatements
reportholdinggainsforgoodssoldduringthe
periodandholdinggainsoninventoryatthe
endoftheperiod?
a.
b.
c.
d.
Goodssold
Yes
Yes
No
No
303
purchas
edless
ending
inventor
yat
current
cost.
Inventory
Yes
No
Yes
No
87. ManhofCo.preparessupplementary
reportsonincomefromcontinuing
operationsonacurrentcostbasis.
HowshouldManhofcomputecostof
goodssoldonacurrentcostbasis?
a. Number
of units
soldtimes
average
current
cost of
units
duringthe
year.
b. Number
of units
sold
times
current
cost of
units at
yearend.
c. Number
of units
sold
times
current
cost of
units at
the
beginning
of the
year.
d. Beginni
ng
inventor
yat
current
cost
plus
costof
goods
88. Whichofthefollowingareexamples
ofconcentrationsthatcreate
vulnerabilitiesandthereforewould
requiredisclosureofrisksand
uncertainties?
I.
a.
b.
c.
d.
IandII.
IIandIII.
IandIII.
I,II,andIII.
89. Whichofthefollowingisrequired
tobedisclosedregardingtherisks
anduncertaintiesthatexist?
a. Factors causing an estimate to be
sensitive.
b.
c.
The
potential
impactof
estimates
about
valuesof
assetsand
liabilities
whenitis
reasonabl
ypossible
thatthe
estimate
will
changein
thenear
future.
The
potential
impact
of
estimate
s about
valuesof
assets
and
liabilitie
swhenit
is
remotely
possible
that the
estimate
will
change
in the
near
future.
d.
A
descri
ption
of the
operati
ons
both
within
and
outsid
e of
the
home
countr
y.
I.
Basisofaccountingusedbyanentityto
fileitsincometaxreturn.
AI. Cash receipts and disbursements basis of
accounting.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
NeitherInorII.
91. Incometaxbasisfinancialstatements
differfromthosepreparedunder
GAAPinthatincometaxbasis
financialstatements
a.
90. Whichofthefollowingaccounting
basesmaybeusedtopreparefinancial
statementsinconformitywitha
comprehensivebasisofaccounting
otherthangenerallyaccepted
accountingprinciples?
Do not
include
nontaxa
ble
revenue
s and
nonde
ductible
expense
s in
determi
ning
income.
b.
d.
Include
detailed
informati
on about
current
and de
ferred
income
tax
liabilities.
c. Contain
no
disclosure
s about
capital
and
operating
lease
transactio
ns.
Recognize certain revenues and
expenses in different reporting
periods.
in the
determin
ation of
income.
c.
d.
93. Ifacompanyusesthemodifiedcash
basisofaccounting,the
modificationsfromthepurecash
basisshouldhavesubstantialsupport.
Inthiscontextsubstantialsupportre
quires
a. T
h
e
fi
n
a
n
c
i
a
l
st
a
t
e
m
e
n
ts
h
a
v
e
o
n
l
y
m
i
n
o
r
m
o
d
if
i
c
a
ti
o
n
s
fr
o
m
G
A
A
P
.
b. The
d.
mod
ifica
tion
s
mus
t be
the
sam
e as
thos
e
requ
ired
by
tax
law.
c. The
modificati
ons must
be the
same as
GAAP
and not
illogical.
Nomodificationsareallowed.
94. Whichofthefollowingisfalse?
a. Prospecti
ve
financial
informati
onmaybe
prepared
for
general or
limited
users.
b. The responsible party is the only
limiteduser.
c. The
financial
projectio
n may
contain
assumpti
ons not
necessari
ly
expected
tooccur.
d. The
financ
ial
projec
tion
may
be
expres
sed as
a
range
of
dollar
s.
95. Prospective financial information is
definedas
a. Any
financial
d.
informati
on about
the past,
present,
orfuture.
b. Any
financial
informati
on about
the
presentor
future.
c. Any
financial
informati
on about
thefuture
related to
the day
today
operation
s.
Any financial information about the
future.
InaccordancewithGAAP.
AI. Using information that is in
accordancewiththeplansof
theentity.
III.Withdueprofessionalcare.
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
304
a.
b.
c.
d.
103.Whichfinancialstatementsshouldbepresentedfora
trust?
IandIII.
IIandIII.
I,II,andIII.
IandII.
I.Statementofassetsandliabilities.
II.Statementofoperations.
III.Statementofcashflows.
IV.Statementofchangesinnetassets.
a. Ionly.
b.IandIIonly.
c.I,II,andIV.
d.I,IIIandIV.
97.Whichofthefollowingdisclosuresshouldprospective
financialstatementsinclude?
a.
b.
c.
d.
d.
Summaryofsignificant
accountingpolicies
Yes
Yes
No
No
Summaryof
significantassumptions
Yes
No
Yes
No
104.Whatisthebasisofaccountingandatwhatamount
areassetsmeasuredonthefinancialstatementsofatrust?
98.WhichofthefollowingistheSECformusedbyissuer
companiestofileasanannualreportwiththeSEC?
a. Form10Q.
b. Form8K.
c. Form10K.
FormS1.
99. Whichofthefollowingbestdescribes
thecontentoftheSECForm10Q?
a. Quarterly audited financial
information and other
information about the
company.
b. Annualauditedfinancial
information and non
financial information
aboutthecompany.
c. Disclosure of material
eventsthataffectthecom
pany.
d. Quarterly reviewed financial
information and other
information about the
company.
100. Which of the following is the SEC
formusedbyissuercompaniestofile
asaquarterlyreportwiththeSEC?
a. Form10Q.
b. Form8K.
c. Form10K.
d. FormS1.
101. Acompanyisrequiredtofilequarterlyfinancial
statementswiththeUnitedStatesSecuritiesand
ExchangeCommissiononForm10Q.The
companyoperatesinanindustrythatisnot
subjecttoseasonalfluctuationsthatcouldhavea
significantimpactonitsfinancialcondition.In
additiontothemostrecentquarterend,for
whichofthefollowingperiodsisthecompany
requiredtopresentbalancesheetsonForm10
Q?
a. The end of the
corresponding
fiscal quarter of
the preceding
fiscalyear.
b. Theendofthe
precedingfiscal
yearandtheendof
thecorresponding
fiscalquarterofthe
a.
b.
c.
d.
c.
Basisofaccounting
Cash
Cash
Accrual
Accrual
precedingfiscal
years.
Theendoftheprecedingfiscalyear.
d. The end of the
preceding fiscal
yearandtheendof
thepriortwofiscal
years.
102. Acompanyisanacceleratedfilerthat
isrequiredtofileForm10Kwiththe
UnitedStatesSecuritiesand
ExchangeCommission(SEC).What
isthemaximumnumberofdaysafter
thecompanysfiscalyearendthat
thecompanyhastofileForm10K
withtheSEC?
a. 60days.
b. 75days.
c. 90days.
d. 120days.
Measurement
Cost
Fairvalue
Cost
Fairvalue
c. Operating
105. GalaxyCorporationpreparesitsfinancial
expenses,
statementsinaccordancewithIFRS.Galaxy
nonoperating
intendstorefinancea$10,000notepayabledue
expenses, and
onFebruary20,2011.Thecompanyexpects
extraordinary
thenotetoberefinancedforaperiodoffive
items.
years.UnderwhatcircumstancescanGalaxy
d. Gross profit, operating profits, and
reportthenotepayableasanoncurrentliability
netprofits.
onitsDecember31,2010statementoffinancial
position?
107. Whichofthefollowingmaynotbe
a. IfGalaxyhastheintentand
disclosed on the income statement
ability to refinance before
for a company that prepares its
December31,2010.
financial statements in accordance
b. IfGalaxyhas executed an
withIFRS?
agreement to refinance
a.
Gainorloss.
beforeDecember31,2010.
b.
Taxexpense.
c. If Galaxy has executed an
c.
Gainorlossfromextraordinaryitems.
agreement to refinance
d. Gain or loss from discontinued
priortotheissuanceofthe
operations.
financial statements in
March2011.
108. Glenda Corporation prepares its financial
d. IfGalaxyhastheintentand
statements in accordance with IFRS. Glenda
abilitytorefinancebefore
must report finance costs on the statement of
theissuanceofthefinancial
cashflows
statementsinMarch2011.
a. Inoperatingactivities.
b. Either
in
106. Largo Corporation prepares its
operating
financial statements in accordance
activities or
with IFRS. Which of the following
financing activi
items is required disclosure on the
ties.
incomestatement?
c. Infinancingactivities.
a. Revenues, cost of
d. In investing activities or financing
goods sold, and
activities.
advertising ex
pense.
109. Larimer Corporation prepares its
b. Finance costs, tax expense, and
financialstatementsinaccordancewith
income.
IFRS.Larimeracquiredequipmentby
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
issuing5,000sharesofits
commonstock.Howshouldthis
transactionbereportedonthe
statementofcashflows?
a.
Asanoutflow
of cash from
investing
activities and
inflowofcash
fromfinancing
activities.
b.
As an inflow of
cash from
financing
activities and an
outflow of cash
from operating
activities.
At the bottom
ofthestatement
ofcashflowsas
a significant
noncash
transaction.
Inthenotesto
the financial
statements as
a significant
noncash
transaction.
c.
d.
110. ForIFRSpurposes,cash
advancesandloansfrom
bankoverdraftsshould
bereportedonthe
statementofcashflows
as
a. Operatingactivities.
b. Investingactivities.
c. Financingactivities.
d. Othersignificantnoncashactivities.
111. Which of the
following
are
acceptable methods
for
reporting
comprehensive
incomeunderIFRS?
I.
Onecomprehensiveincomestatement.
AI. Two statements: an
income statement
and a com
prehensive income
statement.
BI. Inthestatementofownersequity.
a.
b.
c.
d.
Ionly.
IandIIonly.
I,II,andIII.
IandIIIonly.
305
b.
c.
underIFRS?
a. Prior year
comparative
financial
statements
arerequired.
Incomestatementsforthreeyearsarerequired.
Balancesheetsforthreeyearsarerequired.
d. There are
nospecific
requireme
nts
regarding
comparati
ve
financial
statements
.
Nature
Yes
Yes
No
No
Function
Yes
No
Yes
No
114.UnderIFRS,the
statementofcashflowsmay
bepresentedonthe
a.
b.
c.
d.
DirectBasis
Yes
Yes
No
No
IndirectBasis
Yes
No
Yes
No
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
306
SIMULATIONS
TaskBasedSimulation1
Concepts
Authoritative
Literature
Help
Situation
LimCorporationispreparingitsfinancialstatementsandhasgiventheprojecttoitsnewentrylevelaccountant,Sam.
IndicatewhethereachofthefollowingstatementsmadebySamisTrueorFalse.
1.
2.
3.
4.
5.
6.
7.
8.
T
h
T
h
E
A
O
S
e
P
r
TaskBasedSimulation2
FinancialStatement
Classification
Authoritative
Literature
Help
Theoutlinepresentedbelowrepresentsthevariousclassificationssuggestedbythechiefaccountantforthebalance
sheet.
A.
B.
C.
D.
E.
F.
Assets
Current
Investments
Plantandequipment
Intangibles
Deferredcharges
Otherassets
Liabilities
G. Current
H. Longterm
I. Otherliabilities
J.
K.
L.
M.
Ownersequity
Preferredstock
Commonstock
Paidincapitalexcessofpar
Retainedearnings
Other
N. Itemsexcludedfromthe
balancesheet
X. Contravaluationaccount
Items1through18representaccountsoftheCravenCorporation.Determinehoweachaccountwouldbeclassified
fromthelistabove.Iftheaccountisacontraorvaluationaccount,markXbeforetheletter.Forexample:Allowance
forDoubtfulAccountswouldbeXA.Ananswermaybeselectedonce,morethanonce,ornotatall.
Itemstobeanswered
1.
Dividendpayable(onCravenspreferredstock).
2.
Plantconstructioninprogressbythecompany.
3.
Factorybuilding(retiredfromuseandheldforsale).
4.
Land(heldforpossiblefuturebuildingsite).
7.
8.
5.
6.
Stockdividenddistributable(incommonstockto
commonstockholdersandtobeissuedatpar).
Assets
(AF)
Liabilities
(G,H,I)
Ownersequity
(J,K,L,M)
Other
(NorX)
Officesuppliesinventory.
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
Sinkingfundcash(FirstNationalBank,Trustee).
9.
10. Temporarydeclineininventoryvalue.
11. Advancestoofficers(indefiniterepaymentdate).
12. Estimatedwarrantycosts.Thewarrantycostsare
foraoneyearwarrantyonpartsandlabor.
13. Inventoryofsmalltoolsusedinthebusiness.
14. Treasurystockunderparvaluemethod.
15. Commonstocksubscribed(CravenCorporationsstock).
16. Convertiblebonds.
Assets
(AF)
Liabilities
(G,H,I)
Ownersequity
(J,K,L,M)
307
Other
(NorX)
17. Securitiesheldascollateral.
18. Bankoverdraft(onlyaccountwithbank).
TaskBasedSimulation3
BalanceSheet
Authoritative
Literature
Help
Situation
YouhavebeenaskedtoassistthechiefaccountantoftheStephenKingCorporationinthepreparationofa
balancesheet.PresentedbelowisthebalancesheetofStephenKingCorporationforthecurrentyear,2011.
StephenKingCorporation
BALANCESHEET
December31,2011
Currentassets
Investments
Property,plant,andequipment
Intangibleassets
Currentliabilities
Longtermliabilities
Stockholdersequity
$ 435,000
640,000
1,720,000
305,000
$3,100,000
330,000
1,000,000
1,770,000
$3,100,000
Considerthefollowinginformation:
1.
2.
3.
4.
6.
5.
7.
8.
Thecurrentassetssectionincludes:cash$100,000,accountsreceivable$170,000less$10,000forallowance
fordoubtfulaccounts,inventories$180,000,andunearnedrevenue$5,000.Thecashbalanceiscomposedof
$114,000,lessabankoverdraftof$14,000.InventoriesarestatedonthelowerofFIFOcostormarket.
Theinvestmentssectionincludes:thecashsurrendervalueofalifeinsurancecontract$40,000;investmentin
commonstock,shortterm(trading)$80,000andlongterm(availableforsale)$270,000;andbondsinking
fund$250,000.Thecostandfairvalueofinvestmentsincommonstockarethesame.
Property, plant, and equipment includes: buildings $1,040,000 less accumulated depreciation $360,000;
equipment$450,000lessaccumulateddepreciation$180,000;land$500,000;andlandheldforfutureuse
$270,000.
Intangibleassetsinclude:afranchise$165,000;goodwill$100,000;anddiscountonbondspayable$40,000.
Currentliabilitiesinclude:accountspayable$90,000;notespayableshortterm$80,000andlongterm
$120,000;andtaxespayable$40,000.
Longtermliabilitiesarecomposesolelyof10%bondspayableduein2020.
Stockholdersequityhas:preferredstock,noparvalue,authorized200,000shares,issued70,000sharesfor
$450,000;andcommonstock,$1.00parvalue,authorized400,000shares,issued100,000sharesatanaverage
priceof$10.Inaddition,thecorporationhasretainedearningsof$320,000.
Thecompanysmanagementdoesnotelecttousethefairvalueoptionforanyofitsfinancialassetsorliabilities.
Completethecorrectedbalancesheet.TomakeitamorerealisticexamexperienceuseExcel.
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
308
A
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
StephenKingCorporation
BalanceSheet
December31,2011
Currentassets:
Cash
Tradingsecurities
Accountsreceivable(netof$xxxallowancefordoubtfulaccounts)
Inventories(lowerofFIFOcostormarket)
Totalcurrentassets
Investments:
Availableforsalesecurities
Bondsinkingfund
Landheldforfutureuse
Cashsurrendervalueoflifeinsurancecontract
Totalinvestments
Property,plant,andequipment:
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
Land
Buildings(netofaccumulateddepreciationof$xxx)
Equipment(netofaccumulateddepreciationof$xxx)
Totalproperty,plant,andequipment
Intangibleassets:
Franchise
Goodwill
Totalintangibleassets
Totalassets
Currentliabilities:
Accountspayable
Notespayable
Taxespayable
Bankoverdraft
Unearnedrevenue
Totalcurrentliabilities
Longtermliabilities:
Notespayable
Bondspayable,10%duein2020(lessdiscountof$xxx)
Totallongtermliabilities
Totalliabilities
Stockholdersequity:
Paidincapital
Preferredstock,nopar,authorizedxxxshares,issuedxxxshares
Commonstock,$1.00parvalue,authorizedxxxshares,issuedxxxshares
Paidincapitalinexcessofparvaluecommon
Totalpaidincapital
Retainedearnings
Totalstockholdersequity
Totalliabilitiesandstockholdersequity
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
TaskBasedSimulation4
Research
Authoritative
Literature
Help
AssumethatyouareassignedtotheauditofRussellCorporation.TheCFOofRussellistryingtodetermine
howtoclassifyitemswithincomprehensiveincome.WhichsectionoftheProfessionalStandardsaddressesthe
issueofhowtoclassifyitemsincomprehensiveincome?
Enteryourresponseintheanswerfieldsbelow.
TaskBasedSimulation5
Journal
Entries
Authoritative
Literature
Help
Situation
HillsidehadthefollowingselectedaccountbalancesasofDecember31,2010.
Accountsreceivable
Notesreceivable
Prepaidrent
Supplies
Inventory
$250,000
75,000
168,000
60,000
420,000
309
Equipment(historicalcost)
Accountspayable
Salariespayable
Accumulateddepreciation
640,000
176,000
15,000
174,000
ThefollowinginformationwasreceivedfromHillsidesaccountant.Adjustingentrieshavenotyetbeenmade.
1.
2.
3.
4.
5.
6.
7.
Itisestimatedthat$16,000ofaccountswillnotbecollectible.Aprovisionforuncollectibleaccountshas
neverbeenmadebyHillside.
Suppliesremainingattheendoftheyearwere$37,000.
Equipmentisdepreciatedover20yearswitha$60,000salvagevalue.
Accruedsalariesat12/31/10were$37,500.
ThenotereceivablewassignedbythecustomeronNovember1,2010.Itisa6monthnotewithaninterest
rateof12%,withtheprincipleandinterestpaidatmaturity.
RentwaspaidonAugust1,2010,for24monthsandrecordedinaprepaidrentaccount.
Hillsidedoesnotelecttousethefairvalueoptionforanyofitsfinancialassetsorliabilities.
Preparetheadjustingjournalentriesnecessaryforeachitem.Ifnoentryisnecessary,writenoentry.
TaskBasedSimulation6
Calculations
Authoritative
Literature
Help
Situation
HillsidehadthefollowingselectedaccountbalancesasofDecember31,2010.
Accountsreceivable
Notesreceivable
Prepaidrent
Supplies
Inventory
Equipment(historicalcost)
Accountspayable
Salariespayable
Accumulateddepreciation
$250,000
75,000
168,000
60,000
420,000
640,000
176,000
15,000
174,000
ThefollowinginformationwasreceivedfromHillsidesaccountant.Adjustingentrieshavenotyetbeenmade.
1.
Itisestimatedthat$16,000ofaccountswillnotbecollectible.Aprovisionforuncollectibleaccountshas
neverbeenmadebyHillside.
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
310
2.
3.
4.
5.
6.
7.
Suppliesremainingattheendoftheyearwere$37,000.
Equipmentisdepreciatedover20yearswitha$60,000salvagevalue.
Accruedsalariesat12/31/10were$37,500.
ThenotereceivablewassignedbythecustomeronNovember1,2010.Itisa6monthnotewithaninterestrateof
12%,withtheprincipleandinterestpaidatmaturity.
RentwaspaidonAugust1,2010,for24monthsandrecordedinaprepaidrentaccount.
Hillsidedoesnotelecttousethefairvalueoptionforanyofitsfinancialassetsorliabilities.
DeterminetheadjustmentsnecessaryforDecember31,andindicatetheadjustedbalancesoftheselectedaccountsat
December31,2010.
Accountsreceivable(net)
Notesreceivable
Prepaidrent
Supplies
Inventory
Equipment
Accountspayable
Salariespayable
Accumulateddepreciation
TaskBasedSimulation7
Classification/
Disclosures
Authoritative
Literature
Help
GriffinCo.isintheprocessofpreparingitsfinancialstatementsfortheyearendedDecember31,2011.
Items1through6representvarioustransactionsthatoccurredduring2011.Thefollowingtworesponsesarerequired
foreachitem:
Computetheamountofgain,loss,oradjustmenttobereportedinGriffins2011financialstatements.Disregard
incometaxes.OntheCPAexam,alistofnumericanswerchoiceswouldbeprovidedtoselectfrom.
Selectfromthelistbelowthefinancialstatementcategoryinwhichthegain,loss,oradjustmentshouldbe
presented.Acategorymaybeusedonce,morethanonce,ornotatall.
FinancialStatementCategories
Incomefromcontinuingoperations.
Extraordinaryitem.
Cumulativeeffectofchangeinaccountingprinciple.
Priorperiodadjustmenttobeginningretainedearnings.
Separatecomponentofothercomprehensiveincome.
C
o
OnJune30,2011,afterpayingthe
semiannualinterestdueandrecording I
amortizationofbonddiscount,Griffin n
redeemeditsfifteenyear,8%
$1,000,000parbondsat102.Thebonds,
whichhadacarryingamountof
$940,000onJanuary1,2011,had
originallybeenissuedtoyield10%.
Griffinusestheeffectiveinterest
methodofamortization,andhadpaid
interestandrecordedamortizationon
June30.Computetheamountofgainor
lossonredemptionofthebondsand
selecttheproperfinancialstatement
category.
A.
B.
C.
D.
E.
1.
2.
AsofJanuary1,2011,Griffin
decidedtochangethemethodof
computingdepreciationonitssole
pieceofequipmentfromthesum
oftheyearsdigitsmethodtothe
straightlinemethod.The
equipment,acquiredinJanuary
2008for$520,000,hadan
estimatedlifeoffiveyearsanda
salvagevalueof$20,000.
(A)(B)(C)(D)(E)
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
A
m
4.
InNovember2011,Griffin
purchasedtwomarketable
securities,IandII,whichit
boughtandheldprincipallyto
sellintheneartermbyFebruary
28,2012.Relevantdataisas
follows:
I
II
Cost
$125,000
235,000
Computetheamountofholdinggain
orlossatDecember31,2011,and
selecttheproperfinancialstatement
category,assumingGriffinclassifies
thesecuritiesastradingsecurities.
5.
6.
_
_
_
_
During2011,Griffinreceived
$1,000,000fromitsinsurance
companytocoverlossessuffered
duringahurricane.Thiswasthe
firsthurricaneevertostrikein
Griffinsarea.Thehurricane
destroyedawarehousewitha
carryingamountof$470,000,
containingequipmentwitha
carryingamountof$250,000,
andinventorywithacarrying
amountof$535,000andafair
valueof$600,000.Computethe
amountofgainorlossfromthe
financialstatementcategory.
_
_
AtDecember31,2011,Griffin
preparedthefollowingworksheet
summarizingthetranslationofits
whollyownedforeignsubsidiarys
financialstatementsintodollars.Griffin
purchasedtheforeignsubsidiaryfor
$324,000onJanuary2,2011.Onthat
date,thecarryingamountsofthe
subsidiarysassetsandliabilities
equaledtheirfairvalues.
NetassetsJanuary2,2011
(dateofpurchase)
Netincome,2011
NetassetsatDecember31,2011
NetassetsatDecember31,2011
currencyamounts
720,000
250,000
970,000
970,000
311
Computetheamountoftheforeigncurrencytranslationadjustmentand
selecttheproperfinancialstatementscategory.
TaskBasedSimulation8
Research
Authoritative
Literature
Help
AssumethatyouareassignedtotheauditofJaneCorporation.Janehascommitteditselftoaformalplanforsaleofa
businesscomponentthatmeetstherequirementsforpresentationasdiscontinuedoperations.Whichsectionofthe
ProfessionalStandardsaddressestheissueofhowtoaccountforthecoststhatwillbeincurredtorelocateemployeesofthe
discontinuedcomponent?
Enteryourresponseintheanswerfieldsbelow.
TaskBasedSimulation9
Classifications
Authoritative
Literature
Help
Theillustrationsbelowrepresentaccountingtransactionsthataffecttherecognitionofincomeforanaccounting
period.Theirclassificationisthesubjectofthisobjectiveformatmatchingquestion.
Foreachofthetenillustrationsbelow,selectthebestclassificationfromthoselistedAIbelow.Aclassificationmay
beusedonce,morethanonce,ornotatall.
A.
B.
C.
D.
E.
Changeinreportingentity
Correctionofanerror
Changeinaccountingprinciple
Changeinestimate
Extraordinaryitem
Classification
F. DiscontinuedOperationsGainorlossfromdis
continuedoperations
G. Notanaccountingchange
H. Partofnetincomebeforeextraordinaryitems
I.DiscontinuedOperationsGainorlossondisposal
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
312
2.
Newly acquired assets are depreciated using the sum-of-theyears digits method, previously recorded assets are depreciated
using the straight-line method.
Accounting for acquisition of a 100% owned subsidiary.
3.
4.
7.
8.
9. The excess of cash paid over the carrying value to extinguish bonds.
10. Income or loss of the component for the period of disposal included in this
calculation.
TaskBasedSimulation10
MultistepIncome
Statement
Authoritative
Literature
Help
Situation
PresentedbelowisinformationrelatedtoAmericanHorseCompanyfor2010.
Retainedearningsbalance,January1,2010
Salesfortheyear
Costofgoodssold
Interestrevenue
Sellingandadministrativeexpenses
Writeoffofgoodwill(nottaxdeductible)
Incometaxesfor2010
Gainonthesaleofinvestments(normalrecurring)
Lossduetoflooddamageextraordinaryitem(netoftax)
Lossonthedispositionofthewholesaledivision
Lossonoperationsofthewholesaledivision
Incometaxbenefitfromdiscontinuedwholesaledivision
Dividendsdeclaredoncommonstock
Dividendsdeclaredonpreferredstock
$980,000
25,000,000
17,000,000
70,000
4,700,000
820,000
905,000
110,000
390,000
615,000
200,000
285,000
250,000
70,000
AmericanHorseCompanydecidedtodiscontinueitsentirewholesaleoperationsandtoretainits
manufacturingoperations.OnSeptember15,AmericanHorsesoldthewholesaleoperationstoRogers
Company.During2010,therewere300,000sharesofcommonstockoutstandingallyear.
Prepareamultistepincomestatement.
AmericanHorseCompany
INCOMESTATEMENT
FortheYearEndedDecember31,2010
Sales
Netincome
$25,000,000
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
Earningspershare
313
Netincome
TaskBasedSimulation11
Research
Authoritative
Literature
Help
AssumethatyouareassignedtotheauditofClarkCorporation.Clarkhasincurreda
significantlossthatmaymeetthedefinitionofanextraordinaryitem.Whichsectionofthe
ProfessionalStandardsprovidesguidanceonthedefinitionofanextraordinaryitem?
Enteryourresponseintheanswerfieldsbelow.
TaskBasedSimulation12
FinancialStatement
Classification
Authoritative
Literature
Help
Selectfromthelistoffinancialstatementcategoriesbelowthecategoryinwhichtheitemshouldbe
presented.Afinancialstatementcategorymaybeselectedonce,morethanonce,ornotatall.Assume
managementdoesnotelecttousethefairvalueoptionforanyfinancialassetsorliabilities.
FinancialStatementCategories
A.
B.
Incomefromcontinuingoperations,withnoseparatedisclosure.
Incomefromcontinuingoperations,withseparatedisclosure(eitheronthefaceofstatementor
inthenotes).
C.
Othercomprehensiveincomefortheperiod.
D.
Extraordinaryitems.
E.
Separatecomponentofstockholdersequity.
F.
Noneoftheabovecategoriesincludethisitem.
1.
2.
3.
4.
5.
6.
7.
8.
I
I
t
A
n
T
h
I
n
A
A
T
h
T
h
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
314
TaskBasedSimulation13
EarningsPerShare
CalculateNetIncomeand
Authoritative
Literature
Help
Situation
RapCorp.has100,000sharesofcommonstockoutstanding.In2010,thecompanyreportsincome
fromcontinuingoperationsbeforetaxesof$1,210,000.
Additionaltransactionsnotconsideredinthe$1,210,000areasfollows:
1.
2.
3.
4.
5.
In2010,RapCorp.soldequipmentfor$40,000.Themachinehadoriginallycost$80,000
andhadaccumulateddepreciationof$36,000.Thegainorlossisconsideredordinary.
Thecompanydiscontinuedoperationsofoneofitssubsidiariesduringthecurrentyearata
loss of $190,000 before taxes. Assume that this transaction meets the criteria for
discontinuedoperations.Thelossofoperationsofthediscontinuedsubsidiarywas$90,000
beforetaxes;thelossfromdisposalofthesubsidiarywas$100,000beforetaxes.
In 2010, thecompany reviewedits accounts receivable and determinedthat$26,000of
accountsreceivablethathadbeencarriedforyearsappearedunlikelytobecollected.
An internal audit discovered that amortization of intangible assets was understated by
$35,000(netoftax)inapriorperiod.Theamountwaschargedagainstretainedearnings.
The company sold its only investment in common stock during the year at a gain of
$145,000.Thegainistaxedatatotaleffectiverateof40%.Assumethatthetransaction
meetstherequirementsofanextraordinaryitem.
Completethetablebelowforthecalculationofnetincomeandearningspershare.Assumethe
incometaxrateis38%forincomefromcontinuingoperations.
RapCorp.
INCOMESTATEMENT
FortheYearEndedDecember31,2010
Incomefromcontinuingoperationsbeforeincometax
Incometax
Incomefromcontinuingoperations
Discontinuedoperations:
Incomebeforeextraordinaryitem
Extraordinaryitem:
Netincome
Pershareofcommonstock:
Incomefromcontinuingoperations
Discontinuedoperations,netoftax
Incomebeforeextraordinaryitem
Extraordinaryitem,netoftax
Netincome
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
315
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
7.
8.
9.
d
a
a
a
a
d
a
a
b
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
21.
22.
23.
24.
25.
26.
27.
28.
29.
c
c
c
b
b
a
d
d
c
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
41.
42.
43.
44.
45.
46.
47.
48.
49.
d
b
d
d
c
d
b
a
c
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
61.
62.
63.
64.
65.
66.
67.
68.
69.
c
c
a
d
b
a
d
c
d
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
81.
82.
83.
84.
85.
86.
87.
88.
89.
d
b
d
c
a
a
a
d
b
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
101.
102.
103.
104.
105.
106.
107.
108.
109.
c
b
c
d
b
b
c
b
d
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
a
a
c
c
d
b
d
a
b
b
d
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
30.
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
b
a
c
b
d
c
d
b
d
b
a
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
50.
51.
52.
53.
54.
55.
56.
57.
58.
59.
60.
a
b
a
a
c
c
d
b
c
a
a
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
70.
71.
72.
73.
74.
75.
76.
77.
78.
79.
80.
a
b
a
b
c
a
b
c
c
b
a
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
90.
91.
92.
93.
94.
95.
96.
97.
98.
99.
100.
MULTIPLECHOICEANSWEREXPLANATIONS
D.1.IncomeandRetainedEarnings
Statements
+
+
+
1.
(d)BaerFoods2010revenuesshould
includenetsalesrevenue($187,000),
interestrevenue($10,200),andgainon
saleofequipment($4,700),foratotal
of$201,900.Discontinuedoperations
(lossof$12,400)andtheextraordi
narygain($1,500)arebothspecial
itemsthatshouldbereportedas
separatecomponentsofincome,after
incomefromcontinuingoperations.
Therefore,theseitemsshouldnotbe
includedintherevenuessectionofthe
incomestatement(whichisplaced
beforeincomefromcontinuingop
erations).
2.
(a)Todirectlycomputecostofgoods
manufactured(CGM),theformulais
Endingwork
inprocessCost
ofgoods
manufactured
However,noneoftheseelementsaregivenin
thisproblem,soCGMmustbecomputed
indirectly,usingthecostofsalesformula
Beginningfinishedgoods
Costofgoodsmanufactured
Endingfinishedgoods
Costofsales
$400,000
+CGM
360,000
$240,000
Solvingforthemissingamount,CGMis
$200,000.
3.(a)Alloftherevenues,gains,expenses,and
lossesgiveninthisproblemarecomponentsof
incomefromcontinuingoperations.Income
beforeincometaxesis$180,000,ascomputed
below.
Revenues($575,000+$25,000)
$600,000
Expensesandlosses($240,000+$70,000+$10,000
+$50,000+$15,000+$15,000+$20,000)
Incomebeforeincometaxes
$
Tocomputeincomefromcontinuingoperations
(aftertaxes),incometaxes($180,00030%=
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
__
$54,000)mustalsobededucted($180,000
$54,000=$126,000).
Beginningworkinprocess
Directmaterialsused
Directlabor
Factoryoverhead
c
d
a
c
b
d
c
a
c
d
a
110.
111.
112.
113.
114.
a
b
a
a
a
__
__
__
__
__
__
__
__
__
__
1st:__/114=__%
2nd:__/114=__%
4.
5.
(a)Therequirementistocomputetheamountof
expensestobeincludedinsellingexpensesfor
2010.Advertising($150,000)andsalessalaries
andcommissions($140,000)areclearlyselling
expenses,asistherentfortheofficespace
occupiedbythesalesdepartment($220,000
1/2=$110,000).Additionally,freightout
($80,000)isasellingexpensebecauseshipping
thegoodsfromthepointofsaletothecustomer
isthefinaleffortinthesellingprocess.The
totalsellingexpenseis,therefore,$480,000
($150,000+$140,000+$110,000+$80,000).
Theremainingexpensesgivenaregeneraland
administrativeexpenses,exceptforinterestand
thelossonsaleoflongterminvestment,which
arenonoperatingitems(otherexpensesand
losses).
(a)Operatingexpensesareusuallydividedinto
twocategories,sellingexpensesandgeneral
andadministrative(G&A)expenses.Selling
expensesarerelatedtothesaleofacompanys
products,whileG&Aexpensesarerelatedto
thecompanysgeneraloperations.Therefore,
Griffshouldincludethefollowingcostsin
G&Aexpense:
Accountingandlegalfees
Officerssalaries
Insurance
G&Aexpense
$ 25,000
150,000
85,000
$260,000
Freightin($175,000)isaninventoriablecost
whichshouldbereflectedincostofgoodssold
andendinginventory.Freightout,thecostof
deliveringgoodstocustomers($160,000),is
includedinsellingexpenses.Salesrepresen
tativessalaries($215,000)isalsoaselling
expense.
6.(d)Interestexpenseisgenerallyconsidered
tobeanonoperatingitemandistherefore
includedinotherexpensesandlosses.
Operatingexpensesareusuallydividedintotwo
categories,sellingexpensesandgeneraland
administrativeexpenses.Sinceadvertising
expenseisdirectlyrelatedtothesaleofthe
companysproducts,itisincludedinselling
expenses.Therefore,neitheroftheexpenses
givenaregeneralandadministrativeexpenses.
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
316
7.
8.
(a)Charitablecontributionsexpense
shouldincludeallexpensesincurredin
2010byYewCo.whichinvolve
charitablecontributionstoother
entities.Thetotalcharitable
contributionsexpenseis$310,000,
consistingofthe$250,000donatedto
youthandeducationalprogramsand
the$60,000($140,000$80,000)
donatedtohealthandhumanservice
organizations.Theother$80,000was
giventotheseorganizationsbythe
employees,withthecompanymerely
actingasanagentcollectingthat
amountthroughpayrolldeductions
andforwardingitontothe
organizations.Theexpenditurefor
redesigningproductpackaging
($100,000)wouldbeproperly
classifiedasresearchanddevelopment
expense.
(a)Extraordinaryitemsarematerialgainsor
losseswhicharebothunusualinnatureand
infrequentinoccurrence.ForRaimCo.,which
sustainsfloodlosseseverytwotothreeyears,
the2010floodlossisnotinfrequent,andshould
berecognizedasacomponentofincomefrom
continuingoperations.ForCaneCo.,the2010
floodlossisbothunusualandinfrequent,soit
shouldberecognizedasanextraordinaryitem.
9.
(b)Extraordinaryitemsarematerial
itemswhicharebothunusualin
natureandinfrequentinoccurrence.
Theeffectofastrike($175,000)anda
gainorlossfromsaleor
abandonmentofequipment($125,000)isnot
consideredextraordinary.Thelossfromthe
earthquakewouldbeconsideredunusualand
infrequent.Thereforethe$150,000lossis
extraordinary,andthetotalamountof
infrequentlossesnotconsideredextraordinary
is$300,000($175,000+$125,000).
10. (a)Extraordinaryitemsarematerial
itemswhicharebothunusualin
natureandinfrequentinoccurrence.
Disposalsofplantassets,foreign
currencylosses,andinventorylosses
arenotconsideredtobeunusualin
nature,andthusarenotextraordinary.
Itemsthatmayqualifyasextraordi
naryitemsincludesomecasualties,
expropriations,andprohibitionsunder
anewlaw.InKentCo.s2010income
statement,lossesnotconsidered
extraordinaryamountto$610,000.The
factorydisposal($300,000)is
classifiedasdiscontinuedoperations
becausetheoperationscarriedonthere
aredissimilarfromoperationscarried
onattheotherfactories.The$120,000
foreigncurrencylossand$190,000
inventorylossarenotextraordinary
becausetheyarenotunusualinnature.
11. (a)Extraordinaryitemsarematerial
gainsorlosseswhichareboth
unusualinnatureandinfrequentin
occurrence.Foreigncurrencylosses
($1,200,000)andlossesdueto
discontinuedoperations($500,000)
arenotconsideredtobeunusualin
natureandthusarenotextraordinary.
Itemsthatmayqualifyas
extraordinaryincludesome
casualties,expropriations,
prohibitionsunderanewlaw,and
extinguishmentofdebt.Midways
casualtylossappearstobe
extraordinarybecausethehurricane
wasthefirstevertostrikein
Midwaysarea.Thenetpretaxloss
was$100,000[$800,000equipment
loss$700,000buildinggain
($1,000,000$300,000)].
12. (c)Again(loss)mustberecognized
whenanonmonetaryassetis
involuntarilyconvertedinto
monetaryassetsevenifthecompany
reinveststhemonetaryassetsin
replacementnonmonetaryassets.
Thegainorlossisthedifference
betweentheinsuranceproceeds
($1,100,000re
placementcost$50,000deductible=
$1,050,000)andthecarryingamountofthe
assetsdestroyedorusedupasaresultofthe
casualtyloss.Thewarehouse(carryingamount
of$300,000)wasdestroyed,andcashof
$20,000wasusedtocoverremovalcosts.
Therefore,thegainis$730,000[$1,050,000
($300,000+$20,000)].Itisnotanextraordi
naryitembecausestormssimilartotheonethat
destroyedthewarehouseoccurfrequently(every
fouryears).
13.(c)Inthissituation,theprovisionforincome
tax(incometaxexpense)willbetheamountof
thetaxliabilitytothegovernmentdetermined
withoutincludingtheextraordinaryloss.This
amountisdeterminedbyapplyingthe40%tax
ratetopretaxaccountingincomebefore
extraordinaryitemsadjustedforanypermanent
differences.Accountingincomebeforetaxesis
$900,000,butthatamountincludesagainon
lifeinsurancecoverage($100,000).Againon
lifeinsurancecoverageisapermanent
differencebecauseitisincludedinaccounting
incomebutwillneverbeincludedintaxable
income.Therefore,theamountofaccounting
incomewhichwillbesubjecttotaxesis
$800,000($900,000$100,000),andthe
provisionforincometaxesis$320,000
($800,00040%).Thetaxsavingsfromthe
extraordinaryloss($300,00040%=
$120,000)willnotaffecttheprovisionfor
incometaxesbecausetheextraordinaryitem
mustbereportedtogetherwithitstaxeffect
(extraordinarylossof$180,000;netoftax).
14. (d)Netincomeasreported($74,100)
properlyincludedthegainonearly
retirementofbondspayable($22,000)
andthelossfromfire($14,000).The
factthatthegainandlosswere
reportednetoftaxesintheincome
statementwasincorrect,butdoesnot
causethenetincomeamounttobein
error.However,theothertwoitems
shouldnotbereportedintheincome
statementatall.Anunrealizedlosson
noncurrentinvestmentsinstock
($5,400)isreportedinother
comprehensiveincome,notinnet
income.Acorrectionofanerror
($7,500)istreatedasapriorperiod
adjustment.Itisreportedinthe
financialstatementsasanadjustment
tothebeginningbalanceofretained
earnings,ratherthanintheincome
statement.Sincebothoftheseitems
weresubtractedinthecomputationof
reportednetincome,theymustbe
addedbacktocomputethecorrectnet
incomeof$87,000($74,100+$5,400
+$7,500).
15. (b)In2010,BreconCo.wouldreport
onefifthofthecabinetcostsas
depreciationexpenseinselling,
general,andadministrativeexpenses.
Fourfifthsofthecabinetcostwould
remaincapitalizedasfixedassetsat
theendof2010.Thecabinetsare
consideredfixedassetsandnotapart
ofcostofgoodssold.
16. (d)Amaterialgainorlossthatis
unusualinnatureorinfrequentin
occurrence,butnotboth,shouldbe
presentedasaseparatecomponentof
incomeorlossfromcontinuing
operations.Bothdiscontinued
operationsandex
traordinaryitemsarereportedseparatelyafter
incomefromcontinuingoperations.
17.(a)Foranitemtoqualifyasan
extraordinaryitemitmustbebothunusualin
natureandinfrequentinoccurrence.Theabove
criteriamusttakeintoaccounttheenvironment
inwhichtheentityoperates.Anentitywith
salesindifferentcountrieswillexperience
foreigncurrencyrevaluationsonaregular
basis,soacurrencyrevaluationwouldnotbe
infrequentinoccurrenceanditisnotanex
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
traordinaryitem.Gainsfromincreasesin
contractpricesareneitherinfrequentnor
unusual,sotheycannotqualifyasextraordinary
items.
18. (b) Extraordinary items are reported
net of incometaxes as a separate
component of income after
discontinuedoperations.
19. (b)Extraordinaryitemsareeventsand
transactionsthataredistinguishedby
boththeirunusualnatureandthe
infrequencyoftheiroccurrence.
Lossesfromhaildamageareboth
commonandfrequentforToncan.
Estimatesofthelosseswouldnotbe
presentedinthefinancialstatements.
Noamountisrecordeduntilaloss
actuallyoccurs.
D.2.UnusualorInfrequentItems
20.(d)Atransactionthatisunusualinnatureand
infrequent in occurrence is considered an
extraordinary item. An extraordinary item is
reportedafterdiscontinuedoperations.
21. (c)Extraordinaryitemsareeventsand
transactionsthataredistinguishedby
boththeirunusualnatureandthe
infrequencyoftheiroccurrence.
TellerCo.slossarisingfromitsfirst
antitrustactionmeetsbothofthese
criteria(particularlysincethey
pleadedguilty)andshouldtherefore
bereportedasanextraordinaryitem.
ThestrikeagainstTellersmajor
supplier,however,shouldnotbe
reportedasanextraordinaryitem
becauseitisusualinnaturebutmay
beexpectedtorecurasaconsequence
ofcustomaryandcontinuingbusiness
activities.
22. (c)Extraordinaryitemsarematerialitemswhich
arebothunusualinnatureandinfrequentin
occurrence.Therefore,thelossonsaleofabond
investmentisnotextraordinary.Neitheritemis
treatedasextraordinary.
23. (c)Correctionsoferrorsshallcontinue
tobereportednetoftaxinretained
earningsasanadjustmentofthe
beginningbalance.
24. (b)Costsofexitactivities(including
restructuringcharges)shouldbe
measuredandrecognizedatfair
valuewhentheyareincurred.
D.3.DiscontinuedOperations
25. (b)Theoperatinglossof$300,000
($500,000revenuesless$800,000
expenses)relatestoadiscontinued
317
component,soitispartof
discontinuedoperations,notcon
tinuingoperations.Itiscombinedwith
thelossfromdisposalontheincome
statement.Discontinuedoperationsis
acategorydistinctfrom
extraordinaryitems.
26. (a)Managementisnotrequiredto
haveenteredintoasalesagreement.It
issufficientifmanagementiscom
mittedtoadisposalplanthatis
reasonable.Theotheritemsareall
requiredforpresentationas
discontinuedoperations.
27. (d)Indiscontinuedoperations,
presentationoftheincomeorloss
fromoperationsofthecomponentand
thegainorlossondisposalis
required.Sincethecompanymetthe
requirementsforheldforsalestatus
in2010,thesubsidiaryshouldbe
writtendowntoitsfairvaluelesscost
tosell.Thiswouldresultinalossof
$1,500,000($8,000,000carrying
amount$6,500,000fairvalue).
Therefore,thelossfromdiscontinued
operationswouldbe$3,500,000
($2,000,000lossfromoperations+
$1,500,000lossonplanneddisposal).
28. (d)Thelossfromdiscontinued
operationswouldequalthelossfrom
operationsplustheestimatedloss
fromdisposalofthecomponent.
29. (c)Costsofterminationbenefits,lease
termination,andconsolidatingfacilities
orrelocatingemployeesrelatedtoa
disposalactivitythatinvolves
discontinuedoperationsshouldbe
includedintheresultsofdiscontinued
operations.
30. (b)Therequirementistodetermine
howadiscontinuedcomponents
operatinglossesforthecurrent
periodshouldbeclassifiedinthe
financialstatements.Theincome
(loss)fromoperationsiscombined
withthelossondisposal.
31. (a)Gainsorlossesfromthe
operationofadiscontinuedbusiness
componentrealizedfortheperiodare
combinedwiththelossofdisposal
todeterminethelossfrom
discontinuedoperations.
32. (c)Discontinuedoperationsshould
includethegainorlossondisposal
plustheresultsofoperationsduring
theperiod.
D.4.ComprehensiveIncome
33. (b)Thepurposeofreporting
comprehensiveincomeistoreporta
measureofoverallenterprise
performancebydisplayingallchanges
inequityofanenterprisethatresult
fromrecognizedtransactionsandother
economiceventsoftheperiodother
thantransactionswithownersintheir
capacityasowners.Anenterprise
shouldcontinuetodisplayanamount
fornetincomewithequalprominence
tothecomprehensiveincomeamount
displayed.
34. (d)Onceunrealizeditemsrecorded
andreportedinthecurrentorprior
periodarerecognizedasrealizedand
reportedinnetincome,itisnecessary
toreversethemoutofother
comprehensiveincome.The
reclassificationadjustmentistoavoid
doublecounting.Thereclassification
adjustmentinthissituationis$15,000
($25,000gainonAFSsecurities,net
of$10,000tax).
35. (c)TheFASBallowsthree
presentationformats[answer
choices(a),(b),and(d)]witha
preferenceforthefirsttwo
alternatives.
36. (d)Theaccumulatedbalanceofother
comprehensiveincomeshouldbe
reportedasacomponentofequity,
separatefromretainedearningsand
additionalpaidincapital.
37. (b)Comprehensiveincomeisdefined
asthechangeinequityofabusiness
duringaperiodfromtransactionsof
nonownersources.Stockholdersare
ownersofthecorporationorentity,
therefore,transactionsbetweenthe
entityandshareholderarenota
componentofcomprehensiveincome.
38. (d) Assuming the fair value option is not
elected, the calculation of holding gains
recognized in other comprehensive income is
asfollows:
Yearended12/31/09
Yearended12/31/10
Totalgain
Beforetax
$5,000
2,500
$7,500
Incometax
$1,500
750
$2,250
Thereclassificationadjustmentshouldbe
shownnetoftax,so($5,250)istheadjustment
amount.$5,250hadbeenpreviouslyaddedto
othercomprehensiveincomewhenthegains
occurred.The$5,250needstobetakenoutin
orderto
Netoftax
$3,500
1,750
$5,250
318
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
Noticethatstockwarrantsoutstandingare
notincludedaspartofcomprehensive
income.
41. (d)If$2,450(netoftax)isbeing
deductedfromothercomprehensive
incomeasareclassificationadjust
ment,$2,450mustbetheamountof
unrealizedgains(netoftax)thathave
beenrecognizedinother
comprehensiveincome.Therealized
gainswillthenberecognizedin
incomefromcontinuingoperations
beforetax.Thegainsbeforetax
effectsare$3,500($2,45070%).
42. (b)Comprehensiveincomedisclosuresinclude
thechangesduringaperiodofthefollowing
componentsofothercomprehensiveincome:
unrealizedgainsandlossesonavailableforsale
investmentsandforeigncurrencyitems,
includinganyreclassificationadjustments,and
thepensionliabilityadjustmentrequiredto
recognizethefundedstatusoftheplan.Treasury
stockisdeductedfromstockholdersequityand
notacomponentofothercomprehensive
income.
43. (d) Separate EPS calculations are
not required for other
comprehensive income or
comprehensiveincome.
44. (d)TheFASBprefersthat
comprehensiveincomebeshownat
thebottomoftheincomestatementas
acontinuationofnetincomeorina
separatestatementbeginningwithnet
income.Presentingcomprehensive
incomeinthestatementofchangesin
stockholdersequityisnotamethod
thatispreferredbytheFASB.
45. (c)Ifthefairvalueoptionisnot
elected,heldtomaturitysecurities
arereportedatamortizedcost.Any
decreasesorincreasesinfairvalue
arereportedneitherinnetincomenor
aspartofothercomprehensive
income.Answers(a)and(b)are
incorrectbecauseanadjustmentto
pensionliabilitytorecordthefunded
statusoftheplan,andsubsequent
decreasesofthefairvalueof
availableforsalesecuritiesthathave
beenpreviouslywrittendownasim
pairedareincludedinother
comprehensiveincome.Answer(d)
isincorrectbecausedecreasesinthe
fairvalueofheldtomaturity
securitiesarenotpartofother
comprehensiveincome.
(d)Comprehensiveincome(netincomeplus
othercomprehensiveincome)shouldbe
displayedinafinancialstatementthathasthe
sameprominenceasotherfinancialstatements.
Answer(a)isincorrectbecausetheFASBpre
fersthatcomprehensiveincomebedisplayed
eitheratthebottomoftheincomestatement,
continuingfromnetincometoarriveata
comprehensiveincomefigure(equalsnetin
comeplusothercomprehensiveincome),orina
separatestatementofcomprehensiveincome.
Answer(b)isincorrect
becausecomponentsofothercomprehensive
incomemaybedisplayednetofrelatedtax
effectsorbeforerelatedtaxeffectswithone
amountshownfortheaggregateincometax
effect.Answer(c)isincorrectbecause
comprehensiveincomecanbedisplayedinthe
twomethodspreferredbytheFASB(mentioned
above)orinthestatementofchangesin
stockholdersequity.
D.5.BalanceSheets
47.(b)Totalretainedearningsincludesboth
unappropriatedretainedearningsandrestricted
retainedearnings.Therefore,beforeclosing
entries,totalretainedearningsis$1,060,000
($900,000+$160,000).Beforecomputing2010
netincome,taxexpensemustberecorded.
Earnings($6,680,000)lesscostsandexpenses
($5,180,000)resultinpretaxincomeof
$1,500,000.Sincethetaxrateis30%,tax
expenseis$450,000(30%$1,500,000).
Therefore,anadjustmentisnecessarytodebit
incometaxexpenseandcreditprepaidtaxes
for$450,000.Aftertheadjustment,netincome
is$1,050,000($6,680,000$5,180,000
$450,000).Afterclosingentries,totalretained
earningsis$2,110,000($1,060,000+
$1,050,000).
48. (a)Theonlyliabilitiesincludedinthe
trialbalancearebillingsinexcessof
costsonlongtermcontracts
($700,000)andnotepayable
noncurrent($1,620,000).Onlythenote
isnoncurrent.Billingsinexcessof
costsonlongtermcontractsissimilar
tounearnedrevenueandisalways
reportedasacurrentliability.
49. (c)Currentassetslistedinthetrial
balancearecash($600,000),accounts
receivable($3,500,000),costinexcess
ofbillingsonlongtermcontracts
($1,600,000)andprepaidtaxes
($450,000).However,incometax
expensehasnotyetbeenrecorded.
Earnings($6,680,000)lesscostsandex
penses($5,180,000)resultinpretax
incomeof$1,500,000.Sincethetaxrate
is30%,taxexpenseis$450,000(30%
$1,500,000).Therefore,anadjustmentis
necessarytodebitincometaxexpense
andcreditprepaidtaxesfor
$450,000.Totalcurrentassets,afterthis
adjustment,are$5,700,000.
Cash
Accountsreceivable
Costinexcessofbillings
$ 600,000
3,500,000
1,600,000
$5,700,000
50.(a)Mirrbeganoperationson1/1/10with
thefollowingbalancesheetelements:
Assets
$860,000
=
=
Liabilities
$110,000
+ Ownersequity
+
$750,000
During2010,liabilitiesincreasedto$120,000,and
ownersequityincreasedto$765,000[$750,000
beginningbalance+$18,000netincome($82,000
revenues$64,000expenses)
$3,000dividendsdeclared].Therefore,
12/31/10assetsmustbe$885,000.
Assets
Assets
Assets
=
=
=
Liabilities
$120,000
$885,000
+ Ownersequity
+
$765,000
51.(b)Therequirementistodeterminethenet
incomefor2010byanalyzingchangesinthe
balancesheet.Recalltheaccountingequation:
AssetsLiabilities=Stockholdersequity.By
insertingthechangesgivenintothisformula,we
findanincreaseof$62,000existsintheentire
stockholdersequitysection($89,000$27,000=
$62,000).Stockholdersequityiscomposedof
capitalstock,additionalpaidincapitaland
retainedearnings.Becauseincreasesin
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
theothertwobalancesaregiventhattotal
$66,000($60,000+$6,000),theretained
earningsbalancemusthavedecreasedby
$4,000($66,000$62,000).Whendividends
arepaid,thisreducesretainedearnings,while
VelCorp.netincomeincreasesthebalanceof
retainedearnings.Fortheequationtobalance,
thechangesinretainedearningsaccountmust
reducetotalstockholdersequityby$4,000.
Therefore,if$13,000individendsarepaid,
whichreduceretainedearnings,andtotal
retainedearningsaretobereducedby$4,000,
thennetincome,whichincreasesretained
earnings,mustbe$9,000.Thiscreatesthe
$4,000differenceneededtomaketheequation
balance($89,000$27,000=$66,000
$4,000).Thefollowingshowstheanalysisofthe
retainedearningsaccount:
Retainedearnings(beg.)
Netincome(plug)
Dividends
Retainedearnings(decrease)
xxx
9,000
(13,000)
($ 4,000)
52. (a)Idlemachinery($11,200)and
cashsurrendervalueoflifeinsurance
($13,700)arebothassets.Theal
lowancefordeclineinmarketvalue
ofnoncurrentmarketableequity
securities($8,400)isacontraasset
thatisproperlyincludedintheasset
sectionofthebalancesheet(asa
deduction).Theonlyitemlisted
whichshouldnotbeincludedinthe
assetsectionofthebalancesheetis
thetreasurystock($24,000).
Althoughthetreasurystockaccount
hasadebitbalance,itisnotanasset;
instead,itisreportedasacontra
equityaccount.Therefore,the
$24,000mustbeexcludedfromthe
assetsection,reducingthenetasset
amountto$851,000($875,000
$24,000).
53. (a)Althoughthestatementofcash
flowsprovidesinformationabout
liquidity,solvency,andfinancial
flexibility,apotentialinvestorwould
primarilyusethebalancesheetto
assessliquidityandfinancial
flexibility.Thebalancesheethelps
usersanalyzethecompanysabilityto
usecurrentassetstopaycurrent
liabilities(liquidity)andthe
companysabilitytoaltertheamounts
andtimingoffuturecashflowsto
adapttounexpectedneedsortotake
advantageofopportunities
(flexibility).
D.6.a.Disclosures
54. (c)Financialstatementsmustinclude
disclosuresofmaterialtransactions
betweenrelatedparties.Compensation
arrangementsintheordinarycourseof
319
business,however,arespecifically
excludedfromthisdisclosure
requirement.Therefore,onlythe
$250,000saletoaffiliatedenterprises
mustbedisclosed.
55. (c)Disclosureofmaterialtransactions
betweenrelatedpartiesisrequired
exceptfor(1)compensation
agreements,expenseallowances,and
othersimilaritemsintheordinary
courseofbusiness,and(2)
transactionswhichareeliminatedin
thepreparationofconsolidatedor
combinedfinancialstatements.The
officerssalariesandofficers
expensesfallintocategory(1),while
theintercompanysalesfallinto
category(2).Therefore,onlytheloans
toofficers($125,000+$50,000=
$175,000)arereportedasrelatedparty
disclosures.
56. (d)Disclosureofmaterialtransactions
betweenrelatedpartiesisrequired
exceptfor(1)compensation
agreements,expenseallowances,and
othersimilaritemsintheordinary
courseofbusinessand(2)transactions
elimi
natedinthepreparationofconsolidatedor
combinedfinancialstatements.
57.(b)Disclosureofanymaterial
relatedpartytransactionsisrequired
except
1.
2.
Compensationagreements,expense
allowances, and similar items in
theordinarycourseofbusiness.
Transactions that are eliminated in
the preparation of consolidated or
combinedfinancialstatements.
Sincesalesofinventorybetweensubsidiaryand
parentareeliminatedinpreparingconsolidated
financialstatements,suchsalesneednotbe
disclosedasarelatedpartytransaction.
Nonmonetaryexchangesbyaffiliatesarenot
specificallyexemptedfromdisclosure,and
thereforemustbedisclosedasrelatedparty
transactions.Compensationarrangements,
expenseallowances,andsimilaritemsinthe
ordinarycourseofbusinessneednotbedisclosed
asrelatedpartytransactions.However,inthis
casetheallowancesareinexcessofnormal
businesspracticeandthereforemustbedisclosed.
Suretyandguarantyagreementsbetweenrelated
partiesarenotspecificallyexemptedfrom
disclosureandthereforemustbedisclosedas
relatedpartytransactions.
mentsshouldbeproperlypresentedin
accordancewithGAAP;thusno
improperpresentationshouldexist.An
swer(c)isincorrectbecausethetotals
ofthefinancialstatementsshould
includeallitems;thus,noitemswould
beexcluded.Answer(d)isincorrect
becausemanagementsresponsestothe
auditorscommentswouldbecontained
inthemanagementletter,whichisa
separatereporttypicallypresentedto
theauditcommitteeortheboardof
directors.
D.6.b.AccountingPolicies
60. (a)Therequirementistodetermine
whichinformationshouldbe
includedinthesummaryof
significantaccountingpolicies.
Disclosureofaccountingpolicies
shouldidentifyanddescribethe
accountingprinciplesfollowedbythe
reportingentityandmethodsof
applyingthoseprinciples.Answer(a)
iscorrectbecausethemethodof
recordinganddepreciatingassetsis
anexampleofsucharequired
disclosure.Answers(b)and(c)are
incorrectbecausebothrepresentdetail
presentedelsewhereinthefinancial
statements.Answer(d)isincorrect
becauseitisanestimateofearnings
ratherthananaccountingpolicy.
61. (c)Disclosureofaccountingpolicies
shouldidentifyanddescribethe
accountingprinciplesfollowedby
thereportingentityandmethodsof
applyingthoseprinciples.The
criteriafordeterminingwhich
investmentsaretreatedascash
equivalentsisanexampleofhowthe
entityappliesaccountingprinciples.
Thesedisclosuresshouldnotdupli
catedetailspresentedelsewhereas
partofthefinancialstatements.
Answers(a),(b),and(d)arenot
disclosuresof
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
320
accountingpolicies,andalsowouldbe
presentedelsewhereinthefinancialstatements.
62. (c)Thisisarecognizedsubsequent
eventinthefinancialstatement
becauseSwiftrecordsanestimatefor
warrantyliability.Priortoissuingthe
financialstatements,Swiftmustmake
anadjustmentforwarrantyliability
fortheproductrecall.Therefore,
warrantyliabilityshouldbe$68,000
onthe2010balancesheet.
63. (a)Thisisanunrecognized
subsequenteventthatdidnotexistas
ofthebalancesheetdateofDecember
31,2010.Therefore,thereshouldbe
noadjustmentofthe2010financial
statements.However,sincethe
inventorylossismaterialinamount
andthelossisuninsured,toprevent
thefinancialstatementsfrombeing
misleading,Coltershoulddisclosethe
lossinafootnotetothe2010financial
statements.
64. (d)Alossforarecognizedsubsequentevent
shouldbereportedinthecurrentyearfinancial
statements.Therefore,answer(d)iscorrect.
Answer(a)isincorrectbecausealosswouldnot
berecognizedinthecurrentyearforan
unrecognizedsubsequentevent.However,a
footnotedisclosurewouldberequiredforthe
unrecognizedsubsequenteventiftheeventis
materialandthefinancialstatementswouldbe
misleadingiftheeventwerenotdisclosed.An
swer(b)isincorrectbecausegainsarenot
recognizeduntilrealized.Answer(c)is
incorrectbecauserecognizedsubsequentevents
resultinalossrecognizedinthecurrentyear
andacorrespondingadjustmenttorecordthe
liability.
D.6.d.
FairValueMeasurements
65. (b)Thedefinitionoffairvalueisthe
pricethatwouldbereceivedtosellan
assetinanorderlytransactionbetween
marketparticipantsatthe
measurementdate.Answer(a)is
incorrectbecauseitisanentryprice,
notanexitprice.Answer(c)is
incorrectbecauseassetsthatrequireto
berevaluedtofairvalueshouldbe
basedonanexitvalue,notanadjusted
historiccost.Answer(d)isincorrect
becausethepricepaidtoacquirethe
assetisanentryprice,notanexit
price.
66. (a)Theprincipalmarketisthemarket
inwhichthereportingentitywouldsell
theassetortransfertheliabilitywith
thegreatestvolumeandlevelof
activityfortheassetorliability.
Answers(b)and(c)areincorrect
becausetheydonotmeetthe
definitionofprincipalmarket.Answer
(d)isincorrectbecauseitdescribesthe
mostadvantageousmarket.
67. (d)Iflocationisanattributeoftheasset,the
priceintheprincipalmarketshouldbeadjusted
forcoststotransporttheassettoitsprincipalor
mostadvantageousmarket.Answers(a)and(b)
areincorrectbecausepricesarenotadjustedfor
transactioncostssuchassellingcosts.Answer
(c)isincorrectbecausefairvaluesarenotbased
uponentrypricestothemarket.
68. (c)Marketparticipantsarebuyersand
sellersintheprincipalmarketormost
advantageousmarketfortheassetor
liability.Marketparticipantsshouldbe
independent,knowledgeable,ableto
transactfortheasset,andwillingto
transact(i.e.,motivatedbutnot
compelledtodoso).Answer(a)is
incorrectbecausemarketparticipants
shouldnotbecompelledtosell.
Answer(b)isincorrectbecauseitis
notanindependent,unrelatedparty.
Answer(d)isincorrect
becausethedealerisestablishinganewmarket
andisnotintheprincipalmarketthatexistsfor
theasset.
69. (d)Afairvaluemeasurementassumesthe
highestandbestuseoftheassetthatis
physicallypossible,legallypermissible,and
financiallyfeasible.Answers(a)and(b)are
incorrectbecausetodeterminethevaluation
premise,theassetcanbeclassifiedaseitherin
useorinexchange.Answer(c)isincorrect
becauseforvaluationpurposes,thehighestand
bestusewouldmaximizethevalueoftheasset.
70. (a)Thefairvalueatinitialrecognitionisthe
transactionpricethatrepresentsthepricepaid
toacquiretheasset(anentryprice).Answer(b)
isincorrectbecausetransactioncostsarenot
included.Answer(c)isincorrectbecauseitisan
exitprice.Answer(d)isincorrectbecauseitis
notafairvaluemeasure.
71. (b)Therearethreeapproachesto
valuationtechniquesforfairvalue:
themarketapproach,theincomeap
proach,andthecostapproach.There
isnotechniquecalledtheresidual
valueapproach.
72. (a)Theincomeapproachusesvaluation
techniquestoconvertfutureamountstoasingle
presentvalueamount.Therefore,Black
ScholesMerton,binomialmodels,ordis
countedcashflowmodelsareexamplesofthe
incomeapproach.Answers(b)and(c)are
incorrectbecausetheseapproachesdonotuse
presentvaluetechniques.Answer(d)is
incorrectbecausethereisnoexitvalue
approach.
73. (b)Themarketapproachvaluation
techniqueusespricesandother
relevantinformationgeneratedby
markettransactionsinvolving
identicalorcomparableassetsorlia
bilities.Answer(a)isincorrect
becauseitreferstotheincome
approach.Answer(c)isincorrect
becauseitreferstothecostapproach.
Answer(d)isincorrectbecauseitis
notatechniqueforanyofthe
permissiblevaluationtechniques.
74. (c)Achangeinvaluationtechnique
usedtomeasurefairvalueshouldbe
reportedasachangeinaccounting
estimate.Thechangeisreportedona
prospectivebasis;however,the
disclosuresforchangeinaccounting
estimatearenotrequiredforachange
invaluationtechnique.Answers(a),
(b),and(d)areincorrect.
75. (a)Thefairvaluehierarchyprioritizesthe
inputstovaluationtechniquesintothreelevels:
Level1,Level2,andLevel3.Thehighest
priorityisgiventoLevel1inputs,whichare
quotedpricesinactivemarketsforidentical
assetsandliabilities.Answers(b)and(c)are
incorrect,becausetheselevelsarelowerpriority
thanLevel1.Answer(d)isincorrectbecause
thereisnoLevel4input.
76. (b)Thebankprimerateandthedefaultrates
arebothobservableinputs.Afinancialforecast
isdevelopedbyanentityandisanunobservable
inputorLevel3input.Therefore,answers(a),
(c),and(d)areincorrect.
D.6.f. ConstantDollarAccounting
77.(c)TheCodificationencourages,butdoesnot
require,businessenterprisestodisclose
supplementaryinformationontheeffectsof
changingprices.Thestatementpresents
requirementstobefollowedbyenterprisesthat
voluntarilyelecttodisclosethisinformation.
Answers(a)and(b)areincorrectbecausethe
informationisnotreportedinthebodyofthe
financialstatementsorinthenotestothefinancial
statements.Answer(d)isincorrectbecauseman
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
agementsreporttoshareholdersidentifies
managementsresponsibilities,including
responsibilitiesfortheinternalcontrol
system,andwouldnotincludeinformation
aboutchangingprices.
78. (c)Therequirementistodeterminetheamounts
tobereportedforthreebalancesheetaccounts
inasupplementaryconstantdollarbalance
sheet.Inaconstantdollarbalancesheet,
nonmonetaryitemsarerestatedtothecurrent
pricelevel,whilemonetaryitemsarenot
restatedbecausetheyarealreadystatedin
currentdollars.Theinvestmentinbondsand
thelongtermdebtaremonetaryitemssince
theiramountsarefixedbycontractintermsof
numberofdollars.Therefore,theseitemsare
notrestatedandarereportedat$60,000and
$80,000,respectively.Theland,however,isa
nonmonetaryitemanditscost($120,000)must
berestatedtocurrentdollarsbyusingthe
TO/FROMratio(110/100),resultinginan
adjustedamountof$132,000($120,000
110/100).
79. (b)Theaccountloanstoemployees
isamonetaryassetaccountsinceits
paymentamountisfixedatsome
pointinthefuture.Conversely,
merchandiseinventoryisconsidereda
nonmonetaryassetaccountsinceits
valuewillchangebasedonrelative
pricelevelsinthefuture.Thetotal
valueofmonetaryassetsisthe
balanceoftheloanstoemployees
account,or$20,000.
80. (a)Theincreaseincurrentcost(nominal
dollars)of$15,000isthetotalincreasein
currentcost,includinganyincreasecausedby
inflation.Theeffectofchangesinthegeneral
pricelevelisnotseparatedfromtheeffectof
changesinspecificvalue.Theincreasein
currentcost(constantdollars)of$12,000isthe
increaseincurrentcostaftereliminatingany
increasecausedbyinflation.Therefore,the
inflationcomponentoftheincreaseincurrent
costofinventoriesis$3,000($15,000
$12,000).
81. (d)Therequirementistodetermine
whichitemisclassifiedas
nonmonetarywhencomputingthe
purchasingpowergainorlossonnet
monetaryitems.Amonetaryitemis
onethatisfixedordeterminable
withoutreferencetofutureprices.
Accumulateddepreciationisnota
monetaryitem.Advancesto
unconsolidatedsubsidiaries,
allowancefordoubtfulaccounts,and
unamortizedpremiumonbonds
payableareallmonetaryitems.
82. (b)Apurchasingpowergainorlossisthenet
gainorlossdeterminedbyrestatinginunitsof
321
constantpurchasingpowertheopeningand
closingbalancesof,andtransactionsin,
monetaryassetsandliabilities.Duringaperiod
ofrisingprices,monetaryliabilitiesgiveriseto
purchasingpowergainsbecausetheywillbe
settledwithcashwhichcanbeusedtopurchase
relativelyfewergoodsorservicesatafuture
time.
D.6.g.CurrentCostAccounting
83.(d)Currentcostaccountingisamethodof
valuingandreportingassets,liabilities,
revenues,andexpensesattheircurrentcostat
thebalancesheetdateoratthedateoftheiruse
orsale.Aholdinggainisrecordedasan
increaseinanitemsvalue.AtDecember31,
2010,VendCo.isholdingmerchandisewhich
iscurrentlyvaluedat$10perunit(replacement
cost),whiletheoriginalrecordedvalueofthe
merchandisewas$8perunit(purchaseprice).
Therefore,theholdinggainis$2perunit.
84. (c)Therequirementistocalculate
theamountofcurrentcost
depreciationexpensewhichwould
appearinsupplementarycurrentcost
financialstatements.Depreciationis
tobemeasuredbasedontheaverage
currentcostoftheassetduringthe
periodofuse.Theaveragecurrent
costofthismachineduring2010is
$120,000[($115,000+$125,000)
2].Therefore,2010depreciation
expenseis$24,000($120,000 5
yearusefullife).
85. (a)Currentcostforinventoriesand
equipmentismeasuredatthelowerof
currentcostorrecoverableamount.For
equipment,recoverableamount
($95,000)islowerthancurrentcost;for
inventory,currentcost($80,000)is
lowerthanrecoverableamount.
Therefore,thetotalamounttobe
reportedfortheseassetsis$175,000
($95,000+$80,000).
86. (a)Increasesordecreasesinthe
currentcostofinventoryresultfrom
thedifferencebetweenthemeasures
ofassetsattheirentrydates
(beginningofyearorpurchasedate)
andmeasuresofassetsattheirexit
dates(endofyearordateof
use/sale).Basedonthisdefinition,
holdinggainswouldbereportedboth
wheninventoryissoldduringthe
year(realizedgains),andwhen
inventoryisheldattheendofthe
year(unrealizedgains).
87. (a)Thecurrentcostofgoodssoldis
computedbymultiplyingtheaverage
costofunitsproducedorpurchased
duringtheyeartimesthenumberof
unitssold.
D.6.h.
RisksandUncertainites
88. (d)Themarketinwhichanentity
conductsitsoperations,theavailable
sourcesofsupplyofmaterialsusedin
operationsofanentity,andthe
volumeofbusinesstransactedwitha
certaincontributorareallexamplesof
concentrationsthatcreate
vulnerabilitiesthatarerequiredtobe
disclosed.
89. (b)Thepotentialimpactofestimatesabout
valuesofassetsandliabilitieswhenitis
reasonablypossiblethattheestimatewill
changeinthenearfutureisarequireddis
closureregardingsignificantrisksand
uncertainties.Factorscausinganestimatetobe
sensitiveisnotarequireddisclosure,only
recommended.Thepotentialimpactofestimates
aboutvaluesofassetsandliabilitieswhenitis
remotelypossiblethattheestimatewillchange
inthenearfutureisnotarequireddisclosure.It
isonlyarequireddisclosureifitisreasonably
possiblethattheestimateswillchangeinthe
nearfuture.Onlyadescriptionofoperations
outsidethehomecountryisarequired
disclosure.
D.8.OtherComprehensiveBasesof
Accounting
90. (c)Otherthangenerallyaccepted
accountingprinciples,theonlyother
baseswhichmaybeusedtoprepare
financialstatementsinconformity
withacomprehensivebasisof
accountingarethecashbasisanda
basisofaccountingusedtofilean
incometaxreturn.
91. (d)Whenfinancialstatementsare
preparedusinganincometaxbasis,
twoaccountingmethodscanbeused:
(1)modifiedcashbasishybrid
methodofIRSand(2)accrualbasis
IRS.Themodifiedcashbasisreflects
theuseofaccrualbasisfor
inventories,costofgoodssold,sales,
anddepreciation,iftheseare
significant.Theaccrualbasisuses
accrualsanddeferralswithseveral
exceptions(e.g.,prepaidincome,
warrantyexpense).Whenfinancial
statementsarepreparedonanincome
taxbasis,thefinancialstatements
shouldnotsimplyrepeatitemsand
amountsreportedinthe
322
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
includeinformationonthepurpose
ofthestatements,assumptions,and
significantaccountingpolicies.
taxreturn.Thus,itemssuchasnontaxable
municipalinterestandthenondeductible
D.11.SECReportingRequirements
portionoftravelandentertainmentexpense
shouldbefullyreflectedintheincomestatement 98. (c)Therequirementistoidentifytheformused
onthebasisusedfortaxpurposes,withfootnote
tofileasanannualreportwiththeSEC.Answer
disclosureofthedifferencesbetweenthe
(c)iscorrectbecauseForm10Kisthetitleof
amountsreportedintheincomestatementsand
theannualreportrequiredtobefiledannuallyby
taxreturn.
issuercompanies.Answer(a)isincorrect
becausethisisthetitleofthequarterlyfinancial
92. (a)Infinancialstatementspreparedon
report.Answer(b)isincorrectbecauseForm8
theincometaxbasis,the
Kistheinformationreportthatmaybefiled
nondeductibleportionofmealsand
anytimeduringtheyear.Answer(d)isincorrect
entertainmentexpenseshouldbe
becauseaFormS1isaninitialregistration
includedwiththedeductibleportionas
formforsecuritiesundertheSecuritiesActof
atotalamountoftraveland
1933.
entertainmentexpense.Additionally,
thenondeductibleportionshouldbe
99. (d)Therequirementistoidentifythe
footnoted.Answer(a)isthebest
contentoftheSECForm10Q.
answeramongthealternativesgiven,
Answer(d)iscorrectbecausethe
althoughitdoesnotindicatethata
Form10Qpresentsreviewed
footnoteisrequired.
quarterlyinformationandotherin
formationaboutthecompany.
93. (c)Therequirementistoidentifythe
Answer(a)isincorrectbecausethe
statementthatbestdescribes
informationisreviewed,notaudited.
appropriatemodificationsincash
Answer(b)isincorrectbecausethis
basisfinancialstatements.Answer
describestheForm10K.Answer(c)
(c)iscorrectbecausethemodifica
isincorrectbecausethisdescribesthe
tionsshouldbethesameasGAAP
Form8K.
andnotillogical.Answer(a)is
incorrectbecausemodifiedcashbasis
financialstatementsmayhave
substantialmodificationsfromGAAP.
Answer(b)isincorrectbecausethe
modificationsarenotrequiredtobe
thesameasthoserequiredbytaxlaw.
Answer(d)isincorrectbecause
modificationsareallowed.
D.9.
ProspectiveFinancialInformation
94. (b)Theresponsiblepartyisnotthe
onlylimiteduser.Thirdpartieswith
whomtheresponsiblepartyisne
gotiatingdirectlyarealsolimited
users.Answer(a)isincorrectbecause
prospectivefinancialinformationmay
bepreparedforgeneralorlimiteduse.
Answer(c)isincorrectbecauseitis
truethatassumptionsnotnecessarily
expectedtooccurmaybeincludedin
thefinancialprojection.Answer(d)is
incorrectbecausethefinancial
projectionmaybeexpressedasarange
ofdollars.
95. (d) Prospective financial
information is defined as any
financial information about the
future.
96. (c)Financialforecastsandprojectionsmustbe
preparedinaccordancewithGAAP,withthe
plansoftheentity,andwithdueprofessional
careinordertoachieveareasonablyobjective
basis.
97. (a)Prospectivefinancialstatements
100. (a)Therequirementistoidentifythe
formusedtofileasaquarterlyreport
withtheSEC.Answer(a)iscorrect
becauseForm10Qisthetitleofthe
quarterlyreportrequiredtobefiled
byissuercompanies.
101. (c)Therequirementistoidentifythe
balancesheetrequiredintheForm10Q.
Answer(c)iscorrectbecausetheSEC
requiresthataForm10Qcontainan
interimbalancesheetasoftheendof
themostrecentfiscalquarteranda
balancesheetasoftheendofthe
precedingfiscalyear.Aninterim
balancesheetforthefiscalquarterof
theprecedingyeardoesnotneedtobe
providedunlessitisnecessaryfor
understandingtheimpactofseasonal
fluctuations.
102. (b)Therequirementistoidentifythe
deadlineforfilingaForm10Kforan
acceleratedfiler.Answer(b)iscorrect
becausethemaximumnumberofdays
foranacceleratedfilertofilea10K
withtheSECis75daysafterthe
companysfiscalyearend.However,a
largeacceleratedfilerwith$700
millionofpublicfloathasadeadline
of60days,andnonacceleratedfilers
haveadeadlineof90days.
D.12.FinancialStatementsofTrust
103. (c)Therequirementistoidentifythefinancial
statementsofatrust.Astatementofassetsand
liabilities,astatementofoperations,anda
statementofchangesinnetassetsaregenerally
presentedforatrust.
104. (d)Therequirementistoidentifythe
accountingandmeasurementbasesfor
atrust.Thefinancialstatementsofa
trustshouldbepresentedonthe
accrualbasisandtheassetsare
generallymeasuredattheirfair
values.
D.13.InternationalFinancialReporting
Standards
(IFRS)
105. (b)Therequirementistoidentifythe
circumstancesinwhichGalaxymay
presentthenoteasanoncurrentliabil
ity.Answer(b)iscorrectbecause
IFRSrequiresthatGalaxymusthave
executedanagreementtorefinanceat
thebalancesheetdateinorderto
classifythedebtasanoncurrentliabil
ity.Inasmuchasnoagreementexisted
atthebalancesheetdate,thenote
payablemustbeclassifiedasacurrent
liability.Therefore,answers(a),(c),
and(d)areincorrect.
106. (b)Therequirementistoidentifythe
itemrequiredtobedisclosedonthe
incomestatement.Thecorrectansweris
(b)becausetheincomestatementmaybe
preparedbypresentingexpenseseither
bynatureorbyfunction.Theminimum
requireddisclosuresontheincome
statementincludeincome,financecosts,
shareofprofitsandlossesusingthe
equitymethod,taxexpense,discontinued
operations,profitorloss,noncontrolling
interestsinprofitsandlosses,andthenet
profit(loss)attributabletoequityholders
oftheparent.Therefore,answers(a),(c),
and(d)areincorrect.
107. (c)Therequirementistoidentifythe
itemthatmaynotbedisclosedonthe
incomestatementunderIFRS.An
swer(c)iscorrectbecausegainor
lossfromextraordinaryitemsisnot
allowedonanincomestatement
preparedusingIFRS.Answers(a),
(b),and(d)areitemsthatare
disclosedontheincomestatement.
108. (b)Therequirementistoidentify
wherethefinancecostsarepresented
inthestatementofcashflows.An
swer(b)iscorrectbecauseunder
IFRSfinancecosts(interestexpense)
maybereportedineitherthe
operatingorfinancingsectionofthe
statementofcashflows.However,
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
onceitisdisclosedinaparticular
section,itmustbereportedona
consistentbasis.Therefore,answers
(a),(c),and(d),areincorrect.
109. (d)Therequirementisto
identifyhowthetransac
tionshouldbereportedon
thestatementofcash
flows.Answer(d)is
correctbecausethis
transactiondidnot
involveanexchangeof
cash;therefore,itisnot
includedonthestatement
ofcashflows.IFRS
requiresthatsignificant
noncashtransactionsbe
reportedinthenotesto
thefinancialstatements.
(NotethatforUSGAAP,
ifthereareonlyafew
significantnoncash
transactions,theymaybe
reportedatthebottomof
thestatementofcash
flows,ortheymaybere
portedinaseparate
scheduleinthenotesto
thefinancialstatements.)
110. (a)Therequirementisto
identifyhowcashad
vancesandloansfrom
bankoverdraftsshouldbe
reportedonthestatement
ofcashflows.Answer(a)
iscorrectbecauseIFRS
requirescashadvances
andloansfrombank
overdraftstobeclassified
asoperatingactivities.
111. (b)Therequirementis
toidentifythe
acceptablemethodsfor
presentingother
comprehensiveincome.
Answer(b)iscorrect
becauseIFRSprovides
thatcomprehensive
incomemaybe
presentedineitherone
statementorintwo
statements.(USGAAP
allowsthepresentation
inallthreeways.)
112. (a)Therequirementisto
identifythetrue
statementaboutIFRS
requirementsforfinancial
statements.Answer(a)is
correctbecauseIFRS
requiresthepresentation
ofprioryearfinancial
323
statementsfor
comparativepurposes.
113. (a)Therequirementis
toidentifythemanner
inwhichoperating
expensesmaybe
classifiedontheincome
statementunderIFRS.
Answer(a)iscorrect
becausetheymaybe
classifiedbynatureor
function.
114. (a)Therequirementisto
identifyhowthe
statementofcashflows
maybepresented.Answer
(a)iscorrectbecausethe
statementmaybe
presentedonthedirector
theindirectbasis.
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
324
S
O
T
Concepts
Authoritative
Literature
Help
1. Thegainorlossfromdiscontinuedoperationsisplacedinaseparatecategoryunderother
incomeorloss.
2. Thegainorlossfrominfrequentorunusualitemsisgivenextraordinarytreatmentand
disclosedontheincomestatementafterdiscontinuedoperations.
3. Exitanddisposalactivitiesareclassifiedasdiscontinuedoperations.
4. Acomponentofacompanycanbeclassifiedasdiscontinuedinthefirstperiodthatitmeets
thecriteriaasbeingheldforsale.
5. Acorrectionofanerrorisincludedinthecumulativeeffectofchangeinaccounting
principleontheincomestatement.
6. Othercomprehensiveincomemaybepresentedatthebottomoftheincomestatement.
7. Separateearningspershareamountsmustbepresentedforbothothercomprehensive
incomeandcomprehensiveincome.
8. Prospectivefinancialinformationincludesinformationonthepurposeofthestatements,
assumptions,andsignificantaccountingpolicies.
E
1.
2.
3.
(F) Discontinued operations are placed in a separate category after income from
continuingoperationsandbeforeextraordinaryitems.
(F)Anitemmustbebothinfrequentandunusualtobetreatedasanextraordinaryitem.
(F)Exitanddisposalactivitiesthatarenotinconnectionwithacomponentoftheentitythatqualifiesfor
discontinuedoperationsorextraordinarytreatmentshouldbereportedasunusualorinfrequent
income/lossinincomefromcontinuingoperationsbeforeincometaxes.
4.
(T)Acomponentmustbeclassifiedasdiscontinuedwhenitmeetsthecriteria.
5.
(F)Acorrectionofanerrorrequiresrestatementofthefinancialstatements.
6.
(T)Flexibilityisallowedforpresentation.
7.
8.
(F)SeparateEPSamountsareonlyrequiredforgains/lossesfromcontinuingoperations,
discontinued operations, extraordinary items, and cumulative effect of accounting
changes.
(T)Thenotestoprospectivefinancialstatementsmustincludethosedisclosures.
TaskBasedSimulation2
FinancialStatement
Classification
Authoritative
Literature
Help
1.
2.
3.
Factorybuilding(retiredfromuseandheldfor
sale).
4.
Land(heldforpossiblefuturebuildingsite).
5.
6.
Stockdividenddistributable(incommonstock
tocommonstockholdersandtobeissuedat
par).
7.
Officesuppliesinventory.
Assets
(AF)
Liabilities
(G,H,I)
G
Ownersequity
(J,K,L,M)
Other
(NorX)
C
F
B
N
K
A
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
8.
10. Temporarydeclineininventoryvalue.
11. Advances to officers (indefinite repayment
date).
12. Estimatedwarrantycosts.The warrantycosts
areforaoneyearwarrantyonpartsandlabor.
13. Inventoryofsmalltoolsusedinthebusiness.
14. Treasurystockunderparvaluemethod.
15. Common stock subscribed (Craven
Corporationsstock).
16. Convertiblebonds.
17. Securitiesheldascollateral.
18. Bankoverdraft(onlyaccountwithbank).
Explanationofsolutions
325
Assets
(AF)
B
Liabilities
(G,H,I)
Ownersequity
(J,K,L,M)
Other
(NorX)
A
N
F
G
C
XK
K
H
N
G
8.
1.
(G)Whenacorporationdeclaresacashorpropertydividend,theamounttobepaidbecomes
aliabilityofthecorporation.Thedividendspayableamountwouldbeclassifiedasacurrent
liabilityonthebalancesheet.Itisimportanttonotethatdividendspayablerepresentthe
amountdistributedtostockholdersasareturnontheirinvestment.Dividendsarenot
expenses.
2.
(C)Whenanitemofproperty,plant,orequipmentisbeingconstructedbythecompanythat
intendstouseit,alloftherelevantcostsrelatedtotheconstructionshouldbeincludedinthe
asset.Theassetwouldbeclassifiedasplantandequipment.
3.
(F)Afactorybuildingthathasbeenretiredfromuseandheldforsaleshouldbeclassifiedas
anotherassetratherthanasproperty,plantandequipment.Theproperty,plantand
equipmentaccountshouldincludeonlythosetangibleassetsthatarebeingusedinoperations.
4.
(B)Landthatisheldforspeculativeorinvestmentpurposesshouldbeclassifiedasan
investmentratherthanasproperty,plant,andequipment.Theproperty,plant,andequipment
accountshouldrepresentonlythoseassetsbeingusedincurrentoperations.
5.
(N)Consignedinventoryisexcludedfromthebalancesheetbecauseitisnotownedby
Craven.Consignedinventoryrepresentsanarrangementwherebytheownerofthegoods
transfersphysicalpossessiontoanagent(Craven).Theagent(consignee)willattempttosell
thegoodsontheownersbehalf.Theinventoryremainsanassetofitsowner.
6.
(K)Astockdividenddistributablerepresentsadividendtobedistributedtoshareholdersin
theformofadditionalsharesofthecorporationsstock.Eachshareholderwillreceivea
proportionalshareofadditionalstock.Thedeclarationofastockdividenddoesnotresultina
liability,asitdoesnotresultinanyofthecorporationsassetsbeingpaid.Thus,astock
dividenddistributablewouldbeclassifiedasanadditioninthestockholdersequitysectionin
thecommonstockaccount.
7.
(A)Currentassetsrepresentcashorotherassetsthatareexpectedtobeusedwithinthe
operatingcycle.Officesuppliesinventoryrepresentsanassetthatcouldbeexpectedtobe
usedwithintheoperatingcycle.
(B)Generally,afundisagroupofassetssetasideforafuturenonoperatingpurpose.Asinkingfund
containsassetstobeusedinthefuturetoretirebonds.Theseassetsaregenerallyinvestedwhilewaiting
tobeusedandarenoncurrent.
9.
(A)Aninstallmentsalesaccountsreceivableresultswhenthecorporationmakesasaletoa
customeranddoesnotreceivepaymentinfullonthedateofsale.Sincethiscompany
normallysellsontheinstallmentbasis,itsoperatingcyclebecomeseighteenmonths.Its
receivablesarecurrentassetsbecausetheiraveragelifefallswithintheoperatingcycle.
10. (N)Temporarydeclineininventoryvalueisalossandappearsontheincomestatement.
11. (F)Advancestoofficersareconsiderednontradereceivables.Thesetypesofreceivables
shouldbereportedseparatelyonthebalancesheetasotherassets.
12. (G)Awarrantyisaguaranteemadebythesellertothepurchaseragainstdefectsinthe
productsquality.Estimatedwarrantyexpenseforagivenperiodcanbeestimatedasa
percentageofsales.Thepercentageisbasedonpastwarrantyexperience.Theestimated
warrantycostrepresentsthewarrantyexpendituresinthefutureforpastsalesandisacurrent
liability.
13. (C)Property,plant,andequipmentconsistsofitemsusedinthenormaloperationsofa
business.Theinventoryofsmalltoolsrepresentstoolsusedinthebusinessandarenotfor
sale.
14. (XK)Treasurystockisacorporationsownstockwhichhasbeenissuedandreacquired
by the corporation. Treasury stock may be accounted for under the cost or par value
method.Whentheparvaluemethodisused,treasurystockwouldberecordedonthe
balancesheetasareductionorcontratothecommonstockaccount.
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
326
15. (K)Commonstocksubscribedrepresentsstocksubscriptionsthathavenotbeenfullypaid.Thestockisnotconsideredtobe
issueduntilthefullpriceispaid.Thisaccountshouldbeclassifiedasanincreaseinthecommonstockanditisoffsetin
stockholdersequitybyacontraaccountforthebalanceofthesubscriptiondue.
16. (H)Aconvertiblebondisabondwhichmaybeconvertedtoanotherformofthecorporationssecuritiesduringa
specifiedtimeframe.Abondistypicallyclassifiedasalongtermliabilityonthebalancesheet.
17. (N)Corporationsdonotownsecuritiestheyholdascollateral.Thecorporationwillretainthesecuritiesonlyinthe
eventofadefaultonthereceivablethesecuritiesarecollateralizing.Thus,thesecuritiesareexcludedfromthe
balancesheetofCravenandtheyappearonthebalancesheetsoftheirowners.
18. (G)Abankoverdraftoccurswhenacheckiswrittenforagreateramountthanthebalanceinthebankaccount.A
bankoverdraftshouldbeclassifiedasacurrentliability.Itshouldnotbeoffsetagainstothercashaccountbalances
unlessthecashaccountisinthesamebank.
TaskBasedSimulation3
BalanceSheet
Authoritative
Literature
Help
A
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
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32
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35
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39
40
41
42
43
44
StephenKingCorporation
BalanceSheet
December31,2011
Currentassets:
Cash
Tradingsecurities
Accountsreceivable(netof$10,000allowancefordoubtfulaccounts)
Inventories(lowerofFIFOcostormarket)
114,000
80,000
160,000
180,000
Totalcurrentassets
534,000
Investments:
Availableforsalesecurities
Bondsinkingfund
Landheldforfutureuse
Cashsurrendervalueoflifeinsurancecontract
270,000
250,000
270,000
40,000
Totalinvestments
830,000
Property,plant,andequipment:
Land
Buildings(netofaccumulateddepreciationof$360,000)
Equipment(netofaccumulateddepreciationof$180,000)
500,000
680,000
270,000
Totalproperty,plant,andequipment
1,450,000
Intangibleassets:
Franchise
Goodwill
165,000
100,000
Totalintangibleassets
Totalassets
265,000
$3,079,000
Currentliabilities:
Accountspayable
Notespayable
Taxespayable
Bankoverdraft
Unearnedrevenue
$90,000
80,000
40,000
14,000
5,000
Totalcurrentliabilities
229,000
Longtermliabilities:
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
327
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
A
Notespayable
Bondspayable,10%duein2020(lessdiscountof$40,000)
Totallongtermliabilities
Totalliabilities
C
120,000
960,000
1,080,000
$1,309,000
Stockholdersequity:
Paidincapital
Preferredstock,nopar,authorized200,000shares,issued70,000shares
Commonstock,$1.00parvalue,authorized40,000shares,issued100,000shares
Paidincapitalinexcessofparvaluecommon
Totalpaidincapital
450,000
100,000
900,000
$1,450,000
Retainedearnings
320,000
Totalstockholdersequity
Totalliabilitiesandstockholdersequity
1,770,000
$3,079,000
TaskBasedSimulation4
Research
Authoritative
Literature
ASC
220
10
Help
45
13
Authoritative
Literature
Help
TaskBasedSimulation5
JournalEntries
1. Baddebtexpense
16,000
2. Suppliesexpense
23,000
3. Depreciationexpense
29,000
4. Salaryexpense
37,500
Allowanceforuncollectibleaccount
Supplies
[remaining=23,000(60,00037,000)]
Accumulateddepreciation
(640,00060,000)20years=29,000peryear
Salariespayable
5. Interestreceivable
1,500
Interestincome
75,00012%2/12=1,500
6. Rentexpense
328
Prepaidrent
168,00024mo.=7,000permonth5months=35,000
35,000
16,000
23,000
29,000
37,500
1,500
35,000
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
TaskBasedSimulation6
Calculations
Authoritative
Literature
Help
Accountsreceivable(net)
234,000 (1)
Notesreceivable
Prepaidrent
Supplies
Inventory
Equipment(historicalcost)
Accountspayable
Salariespayable
Accumulateddepreciation
75,000
133,000
37,000
420,000
640,000
176,000
52,500
203,000
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
Explanationofsolutions
1.
$250,000$16,000allowanceforuncollectibleaccounts=$234,000
2.
Nochange.Interestreceivableisrecordedinaseparateaccount.
3.
$168,000$35,000=$133,000
4.
Givenintheproblem.
5.
Noadjustmentsweremadetoinventory.
6.
Equipmentisathistoricalcost.
7.
Nochange.
8.
$15,000+$37,500=$52,500
9.
$174,000+$29,000=$203,000
TaskBasedSimulation7
Classification/
Disclosures
Authoritative
Literature
Help
1.($73,000,A)Thenetcarryingamountofthebondsredeemedisdeterminedbyadjustingthecarryingamountofthebondsat
thebeginningoftheyearforanypartialyearamortizationofcorrespondingpremiumsordiscountsandforanyunamortized
issuecosts.Inthisexample,Griffinwoulddetermineitsdiscountamortizationbycomputingthedifferencebetweenitsbond
interestexpenseanditsbondinterestpaidasofJune30,2011.
Bond interest expense
Carrying amount of bonds
at beginning of period
Effective
interest rate
Face value of
bonds
Stated
interest rate
$1,000,000 8% 1/2
Amortization
=
amount
$7,000
Thisamountisaddedtothecarryingamountofthebondsatthebeginningoftheyeartodeterminethenetcarryingamount:
$940,000+$7,000=$947,000.Thisamountissubtractedfromthereacquisitionpricetodeterminethelossonredemption:
$1,020,000($1,000,0001.02)$947,000=$73,000.Gainsorlossesfromearlyredemptionofbondsaretreatedasgainsor
lossesindeterminingnetincome.Earlyextinguishmentofdebtisnotgenerallyconsideredanextraordinaryitem.
2.($50,000,A)Theaccountingchangeisaccountedforonaprospectivebasis.Therefore,itisnecessarytocalculate
thebookvalueoftheassetasofthebeginningoftheyearofthechange.
2008
2009
2010
SYD
$500,0005/15= $166,667
$500,0004/15 = $133,333
$500,0003/15 = $100,000
$400,000
OnJanuary1,2011,thebookvalueiscalculatedasfollows:
Historicalcost
Accumulateddepreciation
Bookvalue1/1/11
$520,000
(400,000)
$120,000
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
329
Straightlinedepreciationfor2011andfutureyearsiscalculatedas
($120,000BV$20,000salvagevalue)2yearsremaininglife=$50,000peryear
Thedepreciationexpensewouldbeshownasapartofthecalculationofincomefromcontinuingoperations.
3.
([$125,000],A)SinceanaccrualwasmadeforGriffinscontingentliabilityin2010,onemustfirstdeterminethe
amountoftheliabilityrecorded.Ifarangeofpossiblelossesexistsandnoamountwithintherangeismorelikely
thananyotheramount,anaccrualshouldbemadefortheminimumamountoftheloss,inthiscase$250,000.As
Griffinaccrueda$250,000liabilityandlossin2010,the2011losswouldbe$125,000($250,000$375,000).Such
alosswouldbeclassifiedunderincomefromcontinuingoperationsasitisincurredinconjunctionwithordinary
operations(amountpaidtoemployee).Suchalosswouldnotbeextraordinaryasitdoesnotmeetthecriteriaof
beingbothunusualinnatureandinfrequentinoccurrence.
4.
([$10,000],A)Tradingsecuritiesaresecuritiesthatareboughtandheldprincipallyforthepurposeofsellingthemin
thenearterm.AsGriffinpurchasedthesesecuritiestosellinthenearterm,anyunrealizedholdinggainorlosswould
appearasincomefromcontinuingoperationsontheincomestatement.Theholdinggainorlossfrommarketable
equitysecuritiesheldinthetradingportfolioiscomputedasofDecember31,2011,bycomparingthecostofthe
securitiesatthepurchasedatewiththefairmarketvalueattheendoftheyear.
Cost
$125,000
235,000
I
II
FV12/31/11
$145,000
205,000
Gain(loss)
$20,000
(30,000)
$(10,000)
5.([$255,000],B)Theamountofgainorlossfromthehurricanewouldbecomputedbyaddingthecarryingamountsof
theassetsdestroyedandcomparingthisamountwiththeamountofinsurancerecovery.ForGriffin,anextraordinaryloss
wouldresultasfollows:
Insurancerecovery
Warehouse
Equipment
Inventory
Totalcarryingvalue
Extraordinaryloss
$ 1,000,000
470,000
250,000
535,000
$ 1,255,000
$ (255,000)
Asthishurricaneisunusualinthatitisnotrelatedtothenormalactivitiesoftheentityandinfrequentinoccurrenceinthatitis
notexpectedtooccuragainintheforeseeablefuture(thiswasthefirsthurricaneeverinGriffinsarea),the$255,000loss
wouldbeclassifiedasanextraordinaryloss.
6.($41,000,E)Tocomputethetranslationadjustmentfor2011,bothnetassetfiguresindollarsmustbecompared.
The$429,000representsthetranslationatthedateofpurchaseplusthetranslationofnetincomeataweightedaverage
exchangerate.The$388,000representsthenetassetsatthetranslatedrateatthebalancesheetdate.The$41,000differenceis
thetranslationadjustmentnecessarytomakethebalancesheetbalance.Thistranslationadjustmentshouldnotbeincludedin
netincome,butshallbereportedasaseparatecomponentofothercomprehensiveincome.
TaskBasedSimulation8
Research
Authoritative
Literature
ASC
T
C
l
A
u
L
i
1.
2.
N
e
A
3.
4.
5.
G
a
420
10
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25
14
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
330
6.
(A)(B)(C)(D)(E)(F)(G)(H)(I)
ChangingfromthegrossprofitmethodfordeterminingyearendinventorybalancestodollarvalueLIFO.
7.
Accountingforexistingconstructioncontractsischangedfromcompletedcontracttopercentageof
completion.
8.
Theeffectsofachangeinestimateandachangeinprincipleareinseparableforthesameevent.
9.
Theexcessofcashpaidoverthecarryingvaluetoextinguishbonds.
10. Incomeorlossofthecomponentfortheperiodofdisposalincludedinthiscalculation.
Explanationofsolutions
1.
2.
8.
(G)Theacquisitionofassetsdoesnotnecessitatethatthesamemethodofdepreciationbeusedfor
thenewlyacquiredassetsasfortheexistingassets.Therefore,nochangeinaccountingprinciple
hasoccurredbecausethepreviouslyrecordedassetswillcontinuetobedepreciatedusingthe
straightlinemethod.
(A)Accountingfortheacquisitionofa100%ownedsubsidiaryisproperlyaccountedforasachangein
reportingentity.
3.
(B)Allcorrectionsoferrorsshouldbetreatedasarestatementofthepriorperiodfinancialstatements.
Thisrequirespromptrecordingoftheerrorintheyearinwhichtheerrorwasdiscovered,and
reportingtheeffectsoftheerrorinthefinancialstatementsasanadjustmenttothecarryingvalueof
theassetsandliabilitiesasofthebeginningofthefirstperiodpresentedwithanoffsettingadjustment
totheopeningbalanceofretainedearningsforthatperiod.Financialstatementsforeachindividual
periodareadjustedtoreflectthecorrectionoftheperiodspecificeffectsoftheerror.
4.
(H)Foranitemtoqualifyasanextraordinaryitemitmustbebothunusualinnatureandinfrequent
inoccurrence.Clearly,thewritedownofinventoryduetoobsolescencedoesnotqualifyfor
extraordinarytreatment;therefore,itshouldbedisclosedseparatelyintheincomestatementbefore
extraordinaryitems.
5.
(I)Gainsorlossesonthedisposalofnetassetsisincludedinthecalculationofgainorlosson
disposalofdiscontinuedoperations.Therefore,thetotalgainorlossondisposalshouldconsistof
thefollowingtwocalculations:thenetassetgainorlossmentionedaboveandtheincomeorloss
fromoperationsfromthemeasurementdatetothedisposaldate(thephaseoutperiod).
6.
(B)Theuseofthegrossprofitmethodtodetermineyearendinventorybalancesisnotproper
GAAP.Therefore,ifasituationsuchasthisexisted,itshouldbetreatedasacorrectionofanerror.
7.
(C)Thechangefromonegenerallyacceptedaccountingprincipletoanotherisconsideredachangein
accountingprinciple.Sinceboththecompletedcontractmethodandthepercentageofcompletion
methodsarerecognizedGAAP,thechangefromonetotheotherisproperlyaccountedforasa
changeinaccountingprinciple,andaccountedforonaretrospectivebasis.
(D)Whenitisimpossibletodeterminewhetherachangeinaccountingprincipleorachangeinestimatehas
occurred,thechangeshouldbeconsideredasachangeinestimate.
9.
(H)Gainsorlossesonextinguishmentofdebtarenolongertreatedasextraordinaryitems.
10. (F)Incomeorlossfromoperationsisproperlyincludedinthecalculationofthegainorlossonthe
discontinuedoperations.Therefore,thiscalculationincludesboththeincomeorlossfromoperations
andthegainorlossonthedisposalofnetassets.Thegainorlossonthedisposalshouldalsobe
disclosedparentheticallyorinthenotestothefinancialstatements.
TaskBasedSimulation10
MultistepIncome
Statement
Authoritative
Literature
Help
AmericanHorseCompany
INCOMESTATEMENT
FortheYearEndedDecember31,2010
Sales
Lesscostofgoodssold
Grossprofit
Lesssellingandadministrativeexpenses
Incomefromoperations
$25,000,000
(17,000,000)
$8,000,000
(4,700,000)
$3,300,000
Otherrevenueandgains
Interestrevenue
Gainonthesaleofinvestments
Otherexpensesandlosses
$70,000
110,000
$180,000
MODULE9BASICTH.&FIN.REP.: D.FINANCIALSTATEMENTS
Writeoffofgoodwill
Incomefromcontinuingoperationsbeforeincometaxes
Incometaxes
Incomefromcontinuingoperations
Discontinuedoperations
Lossondiscontinuedwholesaledivision,includingloss
ondisposalof$200,000
Incometaxbenefit
Lossondiscontinuedoperation(netoftax)
Incomebeforeextraordinaryitem
Extraordinarylossfromflooddamage,netoftax
Netincome
Earningspershare
Incomefromcontinuingoperations
Discontinuedoperations:
Incomebeforeextraordinaryitem
Extraordinaryloss(netoftax)
Netincome
a
$1,755,000$70,000
300,000shares
=$5.62
$1,225,000$70,000
300,000shares
=$3.85
$835,000$70,000
300,000shares
=$2.55
TaskBasedSimulation11
Research
Authoritative
Literature
ASC
T
F
iC
l
L
i
1.
7.
A
n
T
h
I
n
A
8.
2.
3.
4.
5.
6.
225
20
Help
45
331
(820,000)
$2,660,000
(905,000)
$1,755,000
$815,000
(285,000)
(530,000)
$1,225,000
(390,000)
$835,000
a
$5.62
(1.77)
b
3.85
(1.30)
$2.55
1.(B)Changesinthemarketvalueof(tradingtype)marketablesecuritiesshallbeincludedinthe
determinationofincomefromcontinuingoperationsoftheperiodinwhichthechangeinmarketvalueoccurs.
MODULE9BASICTH.&FIN.REP.:D.FINANCIALSTATEMENTS
332
2.
3.
(F)Resultsofoperationsofacomponentthathasbeenorwillbediscontinuedshouldbereportedseparatelyasacomponent
ofincome,afterincomefromcontinuingoperationsbutbeforeextraordinaryitems.
4.
5.
(E)Theaccumulatedchangesinthevaluation(unrealizedexcessofcostovermarketvalue)ofavailableforsale
marketableequitysecuritiesshallbereportedasaccumulatedothercomprehensiveincome.
(B)Aforeignsubsidiarymustremeasureitsfinancialstatementswhenitsfunctionalcurrency(thecurrencyofthe
primaryeconomicenvironmentinwhichtheentityoperates)isdifferentfromitslocalcurrency(thecurrency
currentlyusedbytheentity).Theeffectoftheremeasurementprocess(gainorloss)shouldberecognizedcurrentlyin
income.Aggregategainorlossfortheperiodshouldalsobedisclosedeitherinthefinancialstatementsorinthe
notes.
(C)Whentranslatingaforeignsubsidiarysfinancialstatementsfromfunctionalcurrencytoreportingcurrency,atranslation
adjustmentwillresult.Thetranslationadjustmentisnotincludedinnetincomebutisreportedasacomponentofcompre
hensiveincomeandcalledothercomprehensiveincome.
6.
(D)Extraordinaryitemsareeventsandtransactionsthatarebothunusualandinfrequent.Theearthquakeinthis
problemoccurredinanareapreviouslyconsideredsubjecttoonlyminortremors.Therefore,theearthquakewouldbe
consideredanextraordinaryevent.Extraordinaryitemsshouldbeshownseparatelyontheincomestatement,after
incomefromcontinuingoperations.
7.
(F)Thequestionindicatesthatitisprobablethatthecompanywillreceive$1,000,000fromapendinglawsuit.Thus,
the$1,000,000isagaincontingency.Contingenciesthatmayresultingainsarenotreflectedintheaccounts,as
doingsomightresultintherecognitionofrevenuebeforeitsrealization.Adequatedisclosureofthegaincontingency
shouldbemade,butcareshouldbetakentoavoidmisleadingimplicationsastothelikelihoodofrealization.
8.
(B)Thecostofresearchanddevelopmentservicesperformedbyothersonbehalfoftheenterpriseareincludedin
R&Dcosts.R&Dcostsarechargedtoexpensewhenincurredandthusareincludedinincomefromcontinuing
operationsofthatperiod.Inaddition,separatedisclosureofthetotalR&Dcostsfortheperiodshouldbemade
eitherinthefinancialstatementsorinthenotes.
TaskBasedSimulation13
CalculateNetIncome
andEarningsPerShare
Authoritative
Literature
Help
RapCorp.
INCOMESTATEMENT
FortheYearEndedDecember31,2010
Incomefromcontinuingoperationsbeforeincometax
Incometax
Incomefromcontinuingoperations
Discontinuedoperations:
Lossfromdiscontinuedoperations(includinglossfrom
disposalof$100,000)
Incometaxbenefit
Lossfromdiscontinuedoperations(netoftax)
Incomebeforeextraordinaryitem
Extraordinaryitem:
Gainonsaleofinvestment
Lessapplicabletaxes
Netincome
Pershareofcommonstock:
Incomefromcontinuingoperations
Discontinuedoperations,netoftax
Incomebeforeextraordinaryitem
Extraordinaryitem,netoftax
Netincome($700,800/100,000)
MODULE10INVENTORY
INVENTORY
MULTIPLECHOICEQUESTIONS(168)
$(190,000)
72,200
145,000
58,000
$1,180,000
(448,400)
$ 731,600
117,800
$613,800
87,000
$700,800
$7.32
(1.18)
6.14
0.87
$7.01
333
1.ThefollowinginformationappliedtoFenn,Inc.
for2011:
Merchandisepurchasedforresale
Freightin
Freightout
Purchasereturns
$400,000
10,000
5,000
2,000
Fenns2011inventoriablecostwas
a. $400,000
b. $404,000
c. $408,000
d. $413,000
2.
OnDecember28,2011,KerrManufacturingCo.
purchasedgoodscosting$50,000.Theterms
wereFOBdestination.Someofthecosts
incurredinconnectionwiththesaleanddelivery
ofthegoodswereasfollows:
Packagingforshipment
Shipping
Specialhandlingcharges
$1,000
1,500
2,000
ThesegoodswerereceivedonDecember31,2011.In
KerrsDecember31,2011balancesheet,whatamount
ofcostforthesegoodsshouldbeincludedininventory?
a. $54,500
b. $53,500
c. $52,000
d. $50,000
3.
OnJune1,2011,PittCorp.soldmerchandisewithalist
priceof$5,000toBurronaccount.Pittallowedtradedis
countsof30%and20%.Credittermswere2/15,n/40and
thesalewasmadeFOBshippingpoint.Pittprepaid$200of
deliverycostsforBurrasanaccommodation.OnJune12,
2011,PittreceivedfromBurraremittanceinfullpayment
amountingto
a. $2,744
b. $2,940
c. $2,944
d. $3,140
4.
ThefollowinginformationwastakenfromCody
Co.s accounting records for the year ended
December31,2011:
Decreaseinrawmaterialsinventory
Increaseinfinishedgoodsinventory
Rawmaterialpurchased
Directlaborpayroll
Factoryoverhead
Freightout
a.
b.
c.
d.
$15,000
35,000
430,000
200,000
300,000
45,000
Therewasnoworkinprocessinventoryatthebeginning
orendoftheyear.Codys2011costofgoodssoldis
$895,000
$910,000
$950,000
$955,000
5. ThefollowinginformationpertainstoDealCorp.s
2011costofgoodssold:
Inventory,12/31/10
2011purchases
2011writeoffofobsoleteinventory
Inventory,12/31/11
$90,000
124,000
34,000
30,000
Theinventorywrittenoffbecameobsoleteduetoanunex
pectedandunusualtechnologicaladvancebyacompetitor.
Inits2011incomestatement,whatamountshould
Dealreportascostofgoodssold?
a. $218,000
b. $184,000
c. $150,000
d. $124,000
6.Howshouldthefollowingcostsaffectaretailersin
ventory?
a.
b.
c.
d.
Freightin
Increase
Increase
Noeffect
Noeffect
Interestoninventoryloan
Noeffect
Increase
Increase
Noeffect
Freightcosts
Yes
Yes
No
No
Purchasediscountsnottaken
No
Yes
Yes
No
8.ThefollowinginformationpertainedtoAzurCo.for
theyear:
Purchases
Purchasediscounts
Freightin
Freightout
Beginninginventory
Endinginventory
$102,800
10,280
15,420
5,140
30,840
20,560
WhatamountshouldAzurreportascostofgoodssold
fortheyear?
a. $102,800
b.
c.
d.
$118,220
$123,360
$128,500
9.
Whenallocatingcoststoinventoryproduced
fortheperiod,fixedoverheadshouldbebased
upon
a. Theactualamountsofgoodsproduced
duringtheperiod.
Thenormalcapacityofproductionfacilities.
c. Thehighestproductionlevelsinthe
lastthreeperiods.
d. The lowest production level in
thelastthreeperiods.
b.
MODULE10INVENTORY
334
c.
d.
Recognized as
an expense in
the period in
whichtheyare
incurred.
Allocatedto
workinprocess,
finishedgoods,
andcostof
goodssoldbased
onending
balancesinthe
accounts.
Date
1/1/10
2010layer
2011layer
Whatwasthepriceindexused
tocomputeBachs2011dollar
valueLIFOinventorylayer?
a. 1.09
b. 1.25
c. 1.33
d. 2.00
15. Nest Co. recorded the
following inventory
information during the
monthofJanuary:
Balanceon1/1
Purchasedon1/8
Soldon1/23
Purchasedon1/28
a.
b.
c.
d.
Normalfreightcharges
Handlingcosts
Insuranceonshipment
Abnormalfreightchargesforexpressshipping
Thegoodswerereceivedon
December17,2011.Whatisthe
amountthatFlanaganshouldcharge
toinventoryandtocurrentperiod
expense?
Inventory
$3,000
$5,000
$5,500
$6,700
Currentperiodexpense
$3,700
$1,700
$1,200
$0
14.BachCo.adoptedthedollar
valueLIFOinventorymethodasof
January1,2011.Asingle
inventorypoolandaninternally
computedpriceindexareusedto
computeBachsLIFOinventory
layers.InformationaboutBachs
dollarvalueinventoryfollows:
Units
2,000
1,200
1,800
800
Unitcost
$1
3
NestusestheLIFOmethodtocost
inventory. What amount should
NestreportasinventoryonJanuary
31 under each of the following
methodsofrecordinginventory?
13. OnDecember15,2011,
Flanaganpurchasedgoods
costing$100,000.The
termswereFOBshipping
point.Costsincurredby
Flanaganinconnection
withthepurchaseand
deliveryofthegoods
wereasfollows:
a.
b.
c.
d.
Inventory
Atbase
Atdollar
yearcost
valueLIFO
$90,000
$90,000
20,000
30,000
40,000
80,000
Perpetual
$2,600
$5,400
$2,600
$5,400
Periodic
$5,400
$2,600
$2,600
$5,400
Total
Units
cost
onhand
$2,000
2,000
3,600
3,200
1,400
4,000
2,200
16.Theweightedaverageforthe
yearinventorycostflowmethodis
applicabletowhichofthe
followinginventorysystems?
a.
b.
c.
d.
Periodic
Yes
Yes
No
No
Perpetual
Yes
No
Yes
No
17.DuringJanuary2011,Metro
Co.,whichmaintainsaperpetual
inventorysystem,recordedthe
followinginformationpertaining
toitsinventory:
Balanceon1/1/11
Purchasedon1/7/11
Soldon1/20/11
Purchasedon1/25/11
andnetrealizablevalue.Thenet
realizablevaluelessnormalprofit
marginisbelowtheoriginalcost.
Underthelowerofcostormarket
method,theinventoryitemshould
bevaluedat
a. Replacementcost.
b. Netrealizablevalue.
c. Net realizable value less
normalprofitmargin.
d. Originalcost.
21. Whichofthefollowing
statements are correct
when a company
applying the lower of
cost or market method
Units Unitcost Totalcost
reportsitsinventoryat
1,000
$1
replacementcost?
600
3
900
400
Underthemovingaverage
method,whatamountshould
Metroreportasinventoryat
January31,2011?
a. $2,640
b. $3,225
c. $3,300
d. $3,900
18. Basedonaphysical
inventorytakenon
December31,2011,
ChewyCo.determinedits
chocolateinventoryona
FIFObasisat$26,000
withareplacementcostof
$20,000.Chewy
estimatedthat,after
furtherprocessingcostsof
$12,000,thechocolate
couldbesoldasfinished
candybarsfor$40,000.
Chewysnormalprofit
marginis10%ofsales.
Underthelowerofcostor
marketrule,whatamount
shouldChewyreportas
chocolateinventoryinits
December31,2011
balancesheet?
a. $28,000
b. $26,000
c. $24,000
d. $20,000
19. Reporting inventory at
the lower of cost or
market is a departure
from the accounting
principleof
a. Historicalcost.
b. Consistency.
c. Conservatism.
d. Fulldisclosure.
20. Theoriginalcostofaninventory
itemisbelowbothreplacementcost
I.Theoriginalcostislessthan
replacementcost.
AI. Thenetrealizablevalueisgreater
thanreplacementcost.
a.
b.
c.
d.
Ionly.
IIonly.
BothIandII.
NeitherInorII.
MODULE10INVENTORY
22. Theoriginalcostofan
inventoryitemisabovethe
replacementcostandthe
netrealizablevalue.The
replacementcostisbelow
thenetrealizablevalue
lessthenormalprofit
margin.Asaresult,under
thelowerofcostormarket
method,theinventoryitem
shouldbereportedatthe
a. Netrealizablevalue.
b. Net realizable value less
thenormalprofitmargin.
c. Replacementcost.
d. Originalcost.
23. OnJanuary1,2011,Card
Corp.signedathreeyear
noncancelablepurchase
contract,whichallows
Cardtopurchaseupto
500,000unitsofa
computerpartannually
fromHartSupplyCo.at
$.10perunitand
guaranteesaminimum
annualpurchaseof
100,000units.During
2011,thepart
unexpectedlybecame
obsolete.Cardhad
250,000unitsofthis
inventoryatDecember31,
2011,andbelievesthese
partscanbesoldasscrap
for$.02perunit.What
amountofprobableloss
fromthepurchase
commitmentshouldCard
reportinits2011income
statement?
a. $24,000
b. $20,000
c. $16,000
d. $8,000
b.
c.
d.
Inventorymethod
Perpetual
Individualitem
Totalinventory
Individualitem
25.MarshCompanyhad150units
ofproductAonhandatJanuary1,
2011,costing$21each.Purchases
ofproductAduringthemonthof
Januarywereasfollows:
Jan.10
18
28
Units
200
250
100
Unitcost
$22
23
24
AphysicalcountonJanuary31,
2011,shows250unitsofproductA
onhand.Thecostoftheinventory
atJanuary31,2011,underthe
LIFOmethodis
a. $5,850
b. $5,550
c. $5,350
d. $5,250
26. DuringJanuary2011,
MetroCo.,which
maintainsaperpetual
inventorysystem,
recordedthefollowing
informationpertainingto
itsinventory:
Balanceon1/1/11
Purchasedon1/7/11
Soldon1/20/11
Purchasedon1/25/11
24. ThreadCo.isselectingitsinventory
systeminpreparationforitsfirst
yearofoperations.Threadintendsto
useeithertheperiodicweighted
averagemethodortheperpetual
movingaveragemethod,andto
applythelowerofcostormarket
ruleeithertoindividualitemsorto
thetotalinventory.Inventoryprices
areexpectedtogenerallyincrease
throughout2011,althoughafew
individualpriceswilldecrease.
Whatinventorysystemshould
Threadselectifitwantstomaximize
theinventorycarryingamountatDe
cember31,2011?
a.
335
Perpetual
Periodic
Periodic
Costormarketapplication
Totalinventory
Units
1,000
600
900
400
Unit
cost
$1
3
Total
cost
$1,000
1,800
2,000
Units
onhand
1,000
1,600
700
1,100
c.
d.
UndertheLIFOmethod,what
amountshouldMetroreportas
inventoryatJanuary31,2011?
a. $1,300
b. $2,700
c. $3,900
d. $4,100
b.
c.
d.
Costofgoodssold
Inventory
Costofgoodssold
LIFOreserve
Costofgoodssold
Inventory
Costofgoodssold
LIFOreserve
28.Acompanydecidedtochange
itsinventoryvaluationmethodfrom
FIFOtoLIFOinaperiodofrising
prices.Whatwastheresultofthe
changeonendinginventoryandnet
incomeintheyearofthechange?
a.
b.
Endinginventory
Increase
Increase
Decrease
Increase
27. DrewCo.usestheaveragecost
inventorymethodforinternal
reportingpurposesandLIFOfor
financialstatementandincometax
reporting.AtDecember31,2011,
theinventorywas$375,000using
averagecostand$320,000using
LIFO.Theunadjustedcreditbalance
intheLIFOReserveaccounton
December31,2011,was$35,000.
WhatadjustingentryshouldDrew
recordtoadjustfromaveragecostto
LIFOatDecember31,2011?
a.
Decrease
Decrease
Costofgoodssold
LIFO
LIFO
FIFO
FIFO
Endinginventory
FIFO
LIFO
FIFO
LIFO
30.Duringperiodsofrisingprices,
aperpetualinventorysystemwould
resultinthesamedollaramountof
endinginventoryasaperiodic
inventorysystemunderwhichof
thefollowinginventorycostflow
methods?
Debit
$55,000
FIFO
Yes
Yes
No
No
a.
b.
c.
d.
LIFO
No
Yes
Yes
No
Companyadoptedthedollarvalue
LIFO inventory method. Poes
$20,000 entire inventory constitutes a
single pool. Inventory data for
2010and2011areasfollows:
$20,000
Date
1/1/10
12/31/10
12/31/11
Inventory
atcurrent
yearcost
$150,000
220,000
276,000
PoesLIFOinventoryvalueat
Netincome
December31,2011,is
a.
b.
$230,000
$236,000
Inventory
atbase
yearcost
$150,000
200,000
230,000
Relevant
price
index
1.00
1.10
1.20
MODULE10INVENTORY
336
c.
d.
$241,000
$246,000
32. BrockCo.adoptedthe
dollarvalueLIFO
inventorymethodasof
January1,2010.Asingle
inventorypoolandan
internallycomputedprice
indexareusedto
computeBrocksLIFO
inventorylayers.
Informationabout
Brocksdollarvalue
inventoryfollows:
Date
1/1/10
2010layer
12/31/10
2011layer
12/31/11
Atbase
yearcost
$40,000
5,000
45,000
15,000
$60,000
WhatwasBrocksdollarvalue
LIFOinventoryatDecember31,
2011?
a. $80,000
b. $74,000
c. $66,000
d. $60,000
33. Estimates of pricelevel
changes for specific
inventoriesarerequiredfor
which of the following
inventorymethods?
a.
b.
c.
d.
Conventionalretail.
DollarvalueLIFO.
Weightedaveragecost.
Averagecostretail.
34. Whenthedouble
extensionapproachtothe
dollarvalueLIFO
inventorymethodisused,
theinventorylayeradded
inthecurrentyearis
multipliedbyanindex
number.Whichofthe
followingcorrectlystates
howcomponentsareused
inthecalculationofthis
indexnumber?
a. In
the
numerator, the
average of the
ending inven
toryatbaseyear
cost and at
current year
cost.
b. In
the
numerator, the
ending
inventory at
current year
c.
d.
Inventory
Atcurrent
yearcost
$40,000
14,000
54,000
26,000
$80,000
cost, and, in
the
denominator,
the ending in
ventoryatbase
yearcost.
In
the
numerator, the
endinginventory
atbaseyearcost,
and,
the
denominator,the
endinginventory
at current year
cost.
In
the
denominator,
the average of
the ending in
ventory at base
yearcostandat
current year
cost.
35. JonesWholesalersstocks
achangingvarietyof
products.Which
inventorycostingmethod
willbemostlikelytogive
Jonesthelowestending
inventorywhenits
productlinesaresubject
tospecificprice
increases?
a. Specificidentification.
b. Weightedaverage.
c. DollarvalueLIFO.
d. FIFOperiodic.
36. Dart
Companys
accounting records
indicatedthefollowing
information:
Inventory,1/1/11
Purchasesduring2011
Salesduring2011
Aphysicalinventorytakenon
December31,2011,resultedinan
endinginventoryof$575,000.
Dartsgrossprofitonsaleshas
remainedconstantat25%inrecent
years.Dartsuspectssome
inventorymayhavebeentakenby
anewemployee.AtDecember31,
2011,whatistheestimatedcostof
missinginventory?
a. $25,000
$500,000
2,500,000
3,200,000
b.
c.
d.
a.
b.
c.
d.
$100,000
$175,000
$225,000
Co.
purchasedatractofland
for $1,200,000. Casa
incurred additional cost
of $300,000 during the
remainder of 2011 in
preparing the land for
sale. The tract was
subdivided
into
residential lots as
follows:
Lotclass
A
B
C
Numberoflots
100
100
200
Usingtherelativesalesvalue
method,whatamountofcosts
shouldbeallocatedtotheClassA
lots?
a. $300,000
b. $375,000
c. $600,000
d. $720,000
38.HercCo.sinventoryat
December31,2011,
was$1,500,000basedona
physicalcountpricedatcost,
andbeforeanynecessary
adjustmentforthefollowing:
Merchandisecosting
$90,000,shippedFOB
shippingpointfroma
vendoronDecember30,
2011,wasreceivedand
recordedonJanuary5,
2012.
Goodsintheshippingarea
wereexcludedfromin
ventoryalthough
shipmentwasnotmade
untilJanuary4,2012.
Thegoods,billedtothe
customerFOBshipping
pointonDecember30,
2011,hadacostof
$120,000.
WhatamountshouldHercreportas
inventoryinitsDecember31,
2011balancesheet?
$1,500,000
$1,590,000
$1,620,000
$1,710,000
39.KewCo.saccountspayable
balanceatDecember31,2011,was
$2,200,000beforeconsideringthe
followingdata:
GoodsshippedtoKewFOB
shippingpointonDe
cember22,2011,were
lostintransit.Theinvoice
costof$40,000wasnot
recordedbyKew.On
January7,2012,Kew
fileda$40,000claim
Salespriceperlot againstthecommon
carrier.
OnDecember27,2011,a
vendorauthorizedKewto
return,forfullcredit,goods
shippedandbilledat$70,000
onDecember3,2011.The
returnedgoodswereshipped
byKewonDecember28,
2011.A$70,000creditmemo
wasreceivedandrecordedby
KewonJanuary5,2012.
WhatamountshouldKewreport
asaccountspayableinits
December31,2011balance
sheet?
a. $2,170,000
b. $2,180,000
c. $2,230,000
d. $2,280,000
40. LewisCompanysusual
salestermsarenetsixty
days,FOBshippingpoint.
Sales,netofreturnsand
allowances,totaled
$2,300,000fortheyear
endedDecember31,2011,
beforeyearend
adjustments.Additional
dataareasfollows:
MODULE10INVENTORY
OnDecember27,2011,Lewis
authorizedacustomerto
return,forfullcredit,goods
shippedandbilledat
$50,000onDecember15,
2011.Thereturnedgoods
werereceivedbyLewison
January4,2012,anda
$50,000creditmemowas
issuedandrecordedonthe
samedate.
Goodswithaninvoice
amountof$80,000were
billedandrecordedon
January3,2012.The
goodswereshippedon
December30,2011.
Goodswithaninvoice
amountof$100,000were
billedandrecordedon
December30,2011.The
goodswereshippedon
January3,2012.
Lewisadjustednetsalesfor2011
shouldbe
a. $2,330,000
b. $2,280,000
c. $2,250,000
d. $2,230,000
41. OnJanuary1,2011,Dell,
Inc.contractedwiththe
cityofLittletoprovide
custombuiltdesksforthe
cityschools.Thecontract
madeDellthecityssole
supplierandrequiredDell
tosupplynolessthan
4,000desksandnomore
than5,500desksperyear
fortwoyears.Inturn,
Littleagreedtopayafixed
priceof$110perdesk.
During2011,Dellpro
duced5,000desksfor
Little.AtDecember31,
2011,500ofthesedesks
weresegregatedfromthe
regularinventoryandwere
acceptedandawaiting
pickupbyLittle.Little
paidDell$450,000during
2011.Whatamountshould
Dellrecognizeascontract
revenuein2011?
a. $450,000
b. $495,000
c. $550,000
d. $605,000
42. OnOctober20,2011,
GrimmCo.consigned
fortyfreezerstoHolden
Co.forsaleat$1,000each
andpaid$800in
transportationcosts.On
December30,2011,
337
a.
b.
c.
d.
Holdenreportedthesale
oftenfreezersand
remitted$8,500.The
remittancewasnetofthe
agreed15%commission.
Whatamountshould
Grimmrecognizeas
consignmentsalesreve
nuefor2011?
$7,700
$8,500
$9,800
$10,000
$40,000
36,000
27,000
a.
b.
c.
d.
$49,000
$45,400
$45,000
$40,400
45. SouthgateCo.paidtheintransit
insurancepremiumforconsignment
goodsshippedtoHendonCo.,the
consignee.Inaddition,Southgate
advancedpartofthecommissions
thatwillbeduewhenHendonsells
thegoods.ShouldSouthgateinclude
theintransitinsurancepremiumand
theadvancedcommissionsin
inventorycosts?
a.
b.
c.
d.
Insurancepremium
Yes
No
Yes
No
a.
b.
c.
d.
inventoryamountswere
essentiallyunchanged.
Whichofthefollowing
statementsexplainsthe
increasedinventory
turnoverratio?
Cost of goods sold
decreased.
Accounts receivable
turnoverincreased.
Total asset turnover
increased.
Gross profit percentage
decreased.
50. Selected
data
pertaining
to
Lore
Co.
Advancedcommissions
for the calendar year
2011isasfollows:
46. JelCo.,aconsignee,paid
thefreightcostsforgoods
shippedfromDaleCo.,a
consignor.Thesefreight
costsaretobededucted
fromJelspaymentto
Dalewhenthecon
signmentgoodsaresold.
UntilJelsellsthegoods,
thefreightcostsshouldbe
includedinJels
a. Costofgoodssold.
b. Freightoutcosts.
c. Sellingexpenses.
d. Accountsreceivable.
47. HeathCo.scurrentratio
is 4:1. Which of the
following transactions
wouldnormallyincrease
itscurrentratio?
a. Purchasing inventory on
account.
b. Selling inventory on
account.
c. Collecting an account
receivable.
d. Purchasing machinery for
cash.
48. During2011,RandCo.purchased
$960,000ofinventory.Thecostof
goodssoldfor2011was$900,000,
andtheendinginventoryat
December31,2011,was$180,000.
Whatwastheinventoryturnoverfor
2011?
a. 6.4
b. 6.0
c. 5.3
d. 5.0
49. Inacomparisonof2011
to2010,NeirCo.s
inventoryturnoverratio
increasedsubstantially
althoughsalesand
Netcashsales
Costofgoodssold
Inventoryatbeginningofyear
Purchases
Accountsreceivableatbeginningofyear
Accountsreceivableatendofyear
Lorewouldusewhichofthe
followingtodeterminethe
averagedayssalesin
inventory?
$3,000
18,000
6,000
24,000
20,000
22,000
a.
b.
c.
Numerator
365
365
Averageinventory
Denominator
Averageinventory
Inventoryturnover
Salesdividedby365
MODULE10INVENTORY
338
d.
Salesdividedby365
51.CordBuilders,Inc.has
consistentlyusedthepercentageof
completionmethodofaccountingfor
constructiontypecontracts.During
2010Cordstartedworkona
$9,000,000fixedpriceconstruction
contractthatwascompletedin2012.
Cordsaccountingrecordsdisclosed
thefollowing:
Cumulativecontractcostsincurred
Estimatedtotalcostatcompletion
d.$0
Items55and56arebasedonthe
followingdatapertainingtoPell
Co.sconstructionjobs,which
commencedduring2011:
Inventoryturnover
$3,900,000
7,800,000
Contractprice
Costsincurredduring2011
Estimatedcoststocomplete
Billedtocustomersduring2011
Receivedfromcustomersduring2011
Project1
$420,000
240,000
120,000
150,000
90,000
HowmuchincomewouldCord
haverecognizedonthis
contractfortheyearended
December31,2011?
a. $100,000
b. $300,000
c. $600,000
d. $700,000
52. StateCo.recognizes
constructionrevenueand
expensesusingthe
percentageofcompletion
method.During2010,a
singlelongtermproject
wasbegun,which
continuedthrough2011.
Informationontheproject
follows:
Accountsreceivablefrom
constructioncontract
Constructionexpenses
Constructioninprogress
Partialbillingsoncontract
a.
b.
c.
HowmuchlossshouldHansenhave
recognizedin2011?
$230,000
$100,000
$30,000
$100,000
105,000
122,000
100,000
Profitrecognizedfromthelong
termconstructioncontractin2011
shouldbe
a. $50,000
b. $108,000
c. $128,000
d. $228,000
53. LakeConstruction
Companyhas
consistentlyusedthe
percentageof
completionmethodof
recognizingincome.
During2010,Lake
enteredintoafixedprice
contracttoconstructan
officebuildingfor
$10,000,000.
Informationrelatingto
thecontractisas
follows:
Contractcostsincurredduring2011
were
a. $3,200,000
b. $3,300,000
c. $3,500,000
d. $4,800,000
54. HansenConstruction,
Inc.hasconsistently
usedthepercentageof
completionmethodof
recognizingincome.
During2011,Hansen
startedworkona
$3,000,000fixedprice
constructioncontract.
Theaccountingrecords
disclosedthefollowing
datafortheyearended
December31,2011:
Costsincurred
Estimatedcosttocomplete
Progressbillings
Collections
2010
Percentageofcompletion
Estimatedtotalcostatcompletion
Incomerecognized(cumulative)
Project2
$300,000
280,000
40,000
270,000
250,000
$7,500,000
500,000
$930,000
2,170,000
1,100,000
700,000
55. IfPellusedthe
completedcontract
method,whatamount
ofgrossprofit(loss)
wouldPellreportinits
2011incomestatement?
a. $(20,000)
b. $0
c. $340,000
d. $420,000
56. IfPellusedthe
percentageofcompletion
method,whatamountof
grossprofit(loss)would
Pellreportinits2011
incomestatement?
a. $(20,000)
b. $20,000
c. $22,500
d. $40,000
57. Whichofthefollowingis
used in calculating the
income recognized in
thefourthandfinalyear
of a contract accounted
forbythepercentageof
completionmethod?
a.
b.
c.
d.
Actualtotalcosts
Yes
Yes
No
No
a.
b.
c.
d.
Progress
billingstodate
Yes
No
No
Yes
59. Thecalculationofthe
incomerecognizedinthe
thirdyearofafiveyear
constructioncontract
accountedforusingthe
percentageofcompletion
methodincludestheratioof
a.
b.
c.
d.
Totalcostsincurredtodate
tototalestimatedcosts.
Totalcostsincurredtodate
tototalbillingstodate.
Costincurredinyearthree
tototalestimatedcosts.
Costsincurredinyearthree
tototalbillingstodate.
60. Whenshouldan
anticipatedlossona
longtermcontractbe
recognizedunderthe
percentageofcompletion
methodandthe
completedcontract
Incomepreviouslyrecognized
method,respectively?
Percentageofcompletion
a. Overlifeofproject
b. Immediately
c. Overlifeofproject
d. Immediately
58.Acompanyusedthe
percentageofcompletionmethodof
accountingforafiveyear
constructioncontract.Whichofthe
followingitemswillthecompany
usetocalculatetheincome
recognizedinthethirdyear?
Income
previouslyrecognized
No
Yes
No
Yes
61.Inaccountingforalong
termconstructioncontractusing
thepercentageofcompletion
method,theprogressbillingson
contractsaccountisa
Completedcontract
Contractcomplete
Contractcomplete
Immediately
Immediately
MODULE10INVENTORY
a.
b.
c.
d.
account.
account.
account.
a.
FIFOisallowed.
b.
c.
The weightedaverage
methodisacceptable.
d. Inventories
are always
valuedatnet
realizable
value.
liability
Revenueaccount.
a.
b.
c.
d.
339
Whatistheamountforinventory
thatBradyshouldreportonthe
balancesheetunderthelowerof
costornetrealizablevaluemethod?
$1,000
$900
$850
$750
63.Acompanydeterminedthe
followingvaluesforitsinventory
asoftheendofitsfiscalyear:
Historicalcost
Currentreplacementcost
Netrealizablevalue
Netrealizablevaluelessanormalprofitmargin
Fairvalue
UnderIFRS,whatamountshouldthecompanyreportasinventoryonits
balancesheet?
a. $70,000
b. $85,000
c. $90,000
d. $95,000
64. UnderIFRS,whichofthefollowinginventoryitemsarenotvaluedatthelower
ofcostornetrealizablevalue?
a. Manufacturedinventoryitems.
b. Retailinventoryitems.
c. Biologicalinventoryitems.
d. Industrialinventoryitems.
65. UnderIFRS,thespecificidentificationmethodofaccountingfor
inventoryisrequiredfor
a. Allinventoryitems.
b. Inventoryitemswhichareinterchangeable.
c. Inventoryitemsthatarenotinterchangeableandgoodsthat
areproducedandsegregatedforspecificprojects.
d. Biological(agricultural)inventories.
66. TheinformationprovidedbelowisforaniteminHarrisCorporations
inventoryatyearend.Harrispresentsitsfinancialstatementsin
accordancewithIFRS:
Historicalcost
Estimatedsellingprice
Estimatedcompletionandsellingcosts
Replacementcost
$1,200
1,300
150
1,100
Whatshouldbethevalueofthisinventoryiteminthecompanysfinancial
statements?
a. $1,100
b. $1,150
c. $1,200
d. $1,300
67. Whichofthefollowingisnottrueaboutaccountingforinventory
underIFRS?
MODULE10INVENTORY
340
SIMULATIONS
TaskBasedSimulation1
Concepts
Authoritative
Literature
Help
Indicatewhethereachofthefollowingisincludedinthecostofinventory.
Included
Notincluded
1. Merchandisepurchasedforresale
2. Freightout
3. Directmaterials
4. Salesreturns
5. Packagingforshipmenttocustomer
6. Factoryoverhead
7. Interestoninventoryloan
8. Purchasediscountsnottaken
9. Freightin
10. Directlabor
TaskBasedSimulation2
JournalEntries
Authoritative
Literature
Help
Blaedonusestheperiodicinventorymethodforinventories.Preparethejournalentriesforeachofthefollowing
transactions.Blaedonusesthegrossmethodforrecordinginventorytransactions.
1.
OnJanuary5,2011,purchased$17,000ofgardentillersonaccountfromBestbuiltTillers,terms2/10,n/30,
FOBdestination.Freightchargeswere$200.
2.
OnJanuary10,2011,returnedgardentillersworth$2,000toBestbuiltTillersduetodefects.
3.
OnJanuary14,2011,paidfortheremainingtillerspurchasedin1.
4.
5.
OnJanuary28,2011,purchased$30,000oflawnmowersfromLawnGiant,terms3/10,n/30,FOBshippingpoint.
Thefreightchargeswere$820.
OnFebruary6,2011,paidforthelawnmowerspurchasedinpart4.fromLawnGiant.
TaskBasedSimulation3
Calculations
Authoritative
Literature
Help
Situation
Aclient,BlaedonCo.,sellslawnmowersandgardentillers.ThegardentillersarepurchasedfromBestbuiltTillersand
soldtocustomerswithoutmodification.Thelawnmowers,however,arepurchasedfromseveralcontractors.Blaedonthen
makesongoingdesignrefinementstothemowersbeforesellingthemtocustomers.
Thelawnmowerscost$200.Blaedonthenmakesthedesignrefinementsatacostof$85perlawnmower.Blaedonstores
thelawnmowersinitsownwarehouseandsellsthemdirectlytoretailersatalistpriceof$500.BlaedonusestheFIFOinven
torymethod.Approximatelytwothirdsofnewlawnmowersalesinvolvetradeins.Foreachusedlawnmowertradedinand
returnedtoBlaedon,retailersreceivea$40allowanceregardlessofwhetherthetradeinwasassociatedwithasaleofa2011or
2012model.Blaedonsnetrealizablevalueonausedlawnmoweraverages$25.
AtDecember31,2011,Blaedonsinventoryofnewlawnmowersincludesboth2011and2012models.Whenthe2012
modelwasintroducedinSeptember2011,thelistpriceoftheremaining2011modellawnmowerswasreducedbelowcost.
Blaedonisexperiencingrisingcosts.
Blaedonhascontactedyourfirmforadviceonhowtoreportthecarryingvalueofinventory,theimpactofthedecline
invalueonthe2011models,andtheeffectsofusingtheFIFOmethodontheirDecember31,2011financialstatements.
AssumethatBlaedonhadthefollowinginformationregardingthegardentillerinventory:
MODULE10
Purchases
Purchasediscounts
Purchasereturns
Freightin
Freightout
Beginninginventory
Endinginventory
INVENTORY
341
$210,000
38,000
17,500
12,100
18,000
42,900
34,250
Calculatethefollowingitems:
1.
Goodsavailableforsale
2.
Costsofgoodssold
TaskBasedSimulation4
Research
Authoritative
Literature
Help
AssumethatyouareassignedtotheauditoftheinventoriesofLittonCorporation.ResearchtheProfessionalStandards
forthesectionthatprovidesguidanceontheitemsthatshouldbeincludedinthecostofinventory.Enteryourresponseinthe
answerfieldsbelow.
TaskBasedSimulation5
Calculationof
GrossProfit
Authoritative
Literature
Help
Situation
London,Inc.beganoperationofitsconstructiondivisiononOctober1,2010,andenteredintocontractsfortwoseparate
projects.TheBetaprojectcontractpricewas$600,000andprovidedforpenaltiesof$10,000perweekforlatecompletion.
Althoughduring2011theBetaprojecthadbeenonschedulefortimelycompletion,itwascompletedfourweekslatein
August2012.TheGammaprojectsoriginalcontractpricewas$800,000.Changeordersduring2012added$40,000tothe
originalcontractprice.
Thefollowingdatapertainstotheseparatelongtermconstructionprojectsinprogress:
AsofSeptember30,2011:
Costsincurredtodate
Estimatedcoststocomplete
Billings
Cashcollections
AsofSeptember30,2012:
Costsincurredtodate
Estimatedcoststocomplete
Billings
Cashcollections
Beta
Gamma
$360,000
40,000
315,000
275,000
$410,000
410,000
440,000
365,000
450,000
560,000
560,000
720,000
180,000
710,000
625,000
Additionalinformation
Londonaccountsforitslongterm constructioncontracts usingthepercentageofcompletionmethodforfinancial
reportingpurposesandthecompletedcontractmethodforincometaxpurposes.
Enactedincometaxratesare25%for2011and30%forfutureyears.
Londonsincomebeforeincometaxesfromalldivisions,beforeconsideringrevenuesfromlongtermconstruction
projects,was$300,000fortheyearendedSeptember30,2011.Therewerenoothertemporaryorpermanent
differences.
PrepareascheduleshowingLondonsgrossprofit(loss)recognizedfortheyearsendedSeptember30,2011,and2012,
underthepercentageofcompletionmethod.
342
MODULE10INVENTORY
LondonInc.
SCHEDULEOFGROSSPROFIT(LOSS)
Beta
FortheYearEndedSeptember30,2011:
Estimatedgrossprofit(loss):
Contractprice
Lesstotalcosts
Estimatedgrossprofit(loss)
Percentcomplete:
Costsincurredtodate
Totalcosts
Percentcomplete
Grossprofit(loss)recognized
Gamma
FortheYearEndedSeptember30,2012:
Estimatedgrossprofit(loss):
Contractprice
Lesstotalcosts
Estimatedgrossprofit(loss)
Percentcomplete:
Costsincurredtodate
Totalcosts
Percentcomplete
Grossprofit(loss)recognized
Lessgrossprofit(loss)recognizedinprioryear
Grossprofit(loss)recognized
TaskBasedSimulation6
Disclosures
FinancialStatement
Authoritative
Literature
Help
Situation
London,Inc.beganoperationofitsconstructiondivisiononOctober1,2010,andenteredintocontractsfortwoseparate
projects.TheBetaprojectcontractpricewas$600,000andprovidedforpenaltiesof$10,000perweekforlatecompletion.
Althoughduring2011theBetaprojecthadbeenonschedulefortimelycompletion,itwascompletedfourweekslatein
August2012.TheGammaprojectsoriginalcontractpricewas$800,000.Changeordersduring2012added$40,000tothe
originalcontractprice.
Thefollowingdatapertainstotheseparatelongtermconstructionprojectsinprogress:
AsofSeptember30,2011:
Costsincurredtodate
Estimatedcoststocomplete
Billings
Cashcollections
AsofSeptember30,2012:
Costsincurredtodate
Estimatedcoststocomplete
Billings
Cashcollections
Beta
Gamma
$360,000
40,000
315,000
275,000
$410,000
410,000
440,000
365,000
450,000
560,000
560,000
720,000
180,000
710,000
625,000
Additionalinformation
London accounts for its longterm construction contracts using the percentageofcompletion method for financial
reportingpurposesandthecompletedcontractmethodforincometaxpurposes.
Enactedincometaxratesare25%for2011and30%forfutureyears.
Londonsincomebeforeincometaxesfromalldivisions,beforeconsideringrevenuesfromlongtermconstruction
projects, was $300,000forthe yearendedSeptember30,2011.There were noothertemporaryor permanent
differences.
PreparethefollowingscheduleshowingLondonsbalancesinthefollowingaccountsatSeptember30,2011,under
thepercentageofcompletionmethod:
Accountsreceivable
Costsandestimatedearningsinexcessofbillings
Billingsinexcessofcostsandestimatedearnings
MODULE10INVENTORY
343
LondonInc.
SCHEDULEOFSELECTEDBALANCESHEETACCOUNTS
September30,2011
Accountsreceivable
Costsandestimatedearningsinexcessofbillings:
Constructioninprogress
Less:Billings
Costsandestimatedearningsinexcessofbillings
Billingsinexcessofcostsandestimatedearnings
Estimatedlossoncontract
TaskBasedSimulation7
Research
Authoritative
Literature
Help
AssumethatyouareassignedtotheauditofColeConstructionCompany.Coleconstructsbuildingsunderlongterm
contractsusingthecompletedcontractbasisofaccounting.Colehasdeterminedthatalossisanticipatedonitscontract
withHalecorporation.WhichsectionoftheProfessionalStandardsprovidesguidanceonhowthissituationshouldaffect
Colesfinancialstatements?Enteryourresponseintheanswerfieldsbelow.
TaskBasedSimulation8
InventoryConcepts
Authoritative
Literature
Help
Items1through13representTrueorFalsestatementsconcerninginventoryaccountingmethods.Indicatewhether
eachstatementistrueorfalsebyclickingontheappropriateresponse.
1.
2.
T
h
I
n
3.
4.
5.
U
n
6.
T
h
7.
T
h
U
n
A
8.
9.
10. D
u
11. I
n
12. T
h
13. U
n
MODULE10INVENTORY
344
TaskBasedSimulation9
CostFlowConcepts
Authoritative
Literature
Help
Belowarestatementsdescribinginventoryandcostflowmethods.Identifywhichmethodmatcheseachdescriptionby
clickingonthecorrecttermandplacingitinthespaceprovided.Youmayuseatermonce,morethanonce,ornotatall.
Terms
Specificidentification
Weightedaverage
Simpleaverage
Movingaverage
Firstin,firstout
Lastin,firstout
DollarvalueLIFO
Grossprofit
Method
1.
Duringaperiodofrisingprices,thismethodresultsinahighernetincome.
2.
Thismethodmostcloselymatchesthephysicalflowofinventory.
3.
Methodthatuseshistoricalsalesmarginstoestimateendinginventory.
4.
Methodthatisappropriatewhenthereisarelativelysmallnumberofsignificantdollarvalueitems
ininventory.
5.
Averagecostmustbecalculatedeachtimeadditionalinventoryispurchased.
6.
Methodthataveragesthecostofallitemsonhandandpurchasedduringtheperiod.
7.
Thismethodresultsinthelowestendinginventoryinaperiodofrisingprices.
8.
Methodthatusesapriceindextomeasurechangesininventory.
9.
Ifusedfortaxpurposes,thismethodmustalsobeusedforfinancialreportingpurposes.
10. Thecostofgoodssoldbalanceisthesamewhetheraperpetualorperiodicinventorysystemisused.
TaskBasedSimulation10
Inventory
ScheduleofEnding
Authoritative
Literature
Help
Situation
YorkCo.sellsoneproduct,whichitpurchasesfromvarioussuppliers.YorkstrialbalanceatDecember31,2011,
includedthefollowingaccounts:
Sales(33,000units@$16)
Salesdiscounts
Purchases
Purchasediscounts
Freightin
Freightout
$528,000
7,500
368,900
18,000
5,000
11,000
YorkCo.sinventorypurchasesduring2011wereasfollows:
Beginninginventory,January1
Purchases,quarterendedMarch31
Purchases,quarterendedJune30
Purchases,quarterendedSeptember30
Purchases,quarterendedDecember31
Additionalinformation
Units
8,000
12,000
15,000
13,000
7,000
55,000
Costperunit
$8.20
8.25
7.90
7.50
7.70
Totalcost
$ 65,600
99,000
118,500
97,500
53,900
$434,500
Yorksaccountingpolicyistoreportinventoryinitsfinancialstatementsatthelowerofcostormarket,appliedtototal
inventory.Costisdeterminedunderthelastin,firstout(LIFO)method.
Yorkhasdeterminedthat,atDecember31,2011,thereplacementcostofitsinventorywas$8perunitandthenet
realizablevaluewas$8.80perunit.Yorksnormalprofitmarginis$1.05perunit.
Fromthisinformation,completethefollowingschedules.
MODULE10INVENTORY
345
YorkCo.
SUPPORTINGSCHEDULEOFENDINGINVENTORY
December31,2011
Inventoryatcost(LIFO):
Units
Cost
perunitTotalcost
Beginninginventory,January1
Purchases,quarterendedMarch31
Purchases,quarterendedJune30
Totals
YorkCo.
SCHEDULEOFCOSTOFGOODSSOLD
FortheYearEndedDecember31,2011
Beginninginventory
Add:Purchases
Less:Purchasediscounts
Add:Freightin
Goodsavailableforsale
Less:Endinginventory
Costofgoodssold
TaskBasedSimulation11
Research
Authoritative
Literature
Help
AssumethatyouareassignedtotheauditofHeathCorporation.Heathisconsideringchangingitsmethodof
costinginventory.WhichsectionoftheProfessionalStandardsprovidesguidanceontheappropriatemethodsfor
determininginventorycost?Enteryourresponseintheanswerfieldsbelow.
MODULE10 INVENTORY
346
MULTIPLECHOICEANSWERS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
c
d
c
b
c
a
a
b
b
d
c
a
c
d
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15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
b
b
b
c
a
d
b
b
c
a
c
b
d
c
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__
29.
30.
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
a
a
c
c
b
b
c
a
c
d
a
d
c
d
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__
43.
44.
45.
46.
47.
48.
49.
50.
51.
52.
53.
54.
55.
56.
d
c
c
d
b
b
d
b
a
a
b
b
a
b
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57. a
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58. b
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59. a
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60. d
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61. a
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62. c
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63. c
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64. c
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65. c
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66. b
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67. d
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68. a
__ __
1st:__/68=__%
2nd:__/68=__%
MULTIPLECHOICEANSWEREXPLANATIONS
A. DeterminingInventoryandCostofGoodsSold
1.(c)Inventoriablecostsincludeallcostsnecessary
topreparegoodsforsale.Foramerchandisingconcern
thesecostsincludethepurchasepriceofthegoods,
freightin,insurance,warehousing,andanycosts
necessarytogetthegoodstothepointofsale(except
interestonanyloansobtainedtopurchasethegoods).In
thisproblem,inventoriablecoststotal$408,000.
Purchasepricelessreturns($400,000$2,000)
Freightin
$398,000
10,000
$408,000
Notethatfreightoutisasellingexpense,notan
inventoriablecost,asthediagrambelowindicates.
Customer
Inventoriablecosts
Point
Sellingexpense
ofsale
2.
3.
(d)WhentheshippingtermsareFOBdestination,
thesellerbearsallcostsoftransportingthegoods
tothebuyer.Therefore,thesellerisresponsible
forthepaymentofpackagingcosts($1,000),
shippingcosts($1,500),andthespecialhandling
charges($2,000).Theonlyamounttobeincluded
asthebuyerscostoftheinventorypurchasedis
thepurchaseprice($50,000).
(c)Purchasesarealwaysrecordednetoftradediscounts.
Whenmorethanonetradediscountisappliedtoalistprice,
itiscalledachaindiscount.Chaindiscountsareappliedin
steps;eachdiscountappliestothepreviouslydiscounted
price.Thecost,netoftradediscounts,is$2,800[$5,000
(30%$5,000)=$3,500;and$3,500(20%$3,500)=
$2,800].Paymentwasmadewithinthediscountperiod,so
thenetpurchasepriceis$2,744[$2,800(2%$2,800)].
TheremittancefromBurrwouldalsoincludere
imbursementofthe$200ofdeliverycosts.Sincetheterms
wereFOBshippingpoint,Burrisresponsibleforpaying
thisamount,andmustreimbursePitt,whoprepaidthe
freight.Thus,thetotalremittanceis$2,944($2,744+
$200).
4.
(b)Threecomputationsmustbeperformed:raw
materialsused,costofgoodsmanufactured,and
costofgoodssold.
$430,000
15,000
$445,000
-445,000
200,000
300,000
945,000
-$945,000
$945,000
35,000
$910,000
ThedecreaseinRMinventoryisaddedwhencomputingRM
usedbecauseRMwereusedinexcessofthosepurchased.
TheincreaseinFGinventoryisdeductedwhencomputing
costofgoodssoldbecauseitrepresentstheportionofgoods
manufacturedwhichwerenotsold.Thefreightoutis
irrelevantforthisquestionbecausefreightoutisaselling
expenseandthereforedoesnotaffectcostofgoodssold.
5.
(c)Tocomputecostofgoodssold,thesolutions
approachistosetupaTaccountforinventory
12/31/10
Purchases
12/31/11
Inventory
90,000
124,000
34,000
?
30,000
Writeoff
Costofgoodssold
Purchasesincreaseinventory,whilethewriteoffandcost
ofgoodssolddecreaseinventory.Costofgoodssoldcan
becomputedas$150,000usingtheTaccount.An
alternatesolutionsapproachistousetheCGS
computation
BI
$ 90,000
+ Purchases 124,000
CGAS
214,000
EI
(30,000)
$184,000
6.
Theoreticallycorrecttreatment.
(a)Thecostofinventoryshouldincludeallexpenditures
(directandindirect)incurredtobringanitemtoitsex
istingconditionandlocation.Freightinchargesarethus
appropriatelyincludedininventorycosts.Interestcost
shallnotbecapitalizedforassetsthatareinuseorreadyfor
theirintendeduseintheearningsactivitiesofthe
enterprise.Thus,
MODULE10INVENTORY
interestonaninventoryloanshouldnotbeincludedin
inventory(itshouldbeexpensedasincurred).
7.
8.
as
(a)Thecostofinventoryshouldincludeall
expenditures(directandindirect)incurredto
bringanitemtoitsexistingconditionand
location.Freightchargesarethusappropriately
includedininventorycosts.Underthenet
purchasemethod,purchasediscountsnottaken
arerecordedinaPurchaseDiscountsLost
account.Whenthismethodisused,purchase
discountslostareconsideredafinancial(i.e.,
other)expense,andarethusexcludedfromthe
costofinventory.
(b)Azurshouldreportcostofgoodssoldcalculated
Costofgoodssold(CGS)=Beg.Inventory+Net
purchases*+FreightinEndingInventory
CGS=$30,840+$92,520**+$15,420$20,560
CGS=$118,220
Freightoutisasellingexpenseanddoesnotenterthe
calculationofcostofgoodssold.
*
*
($102,800$10,280)
9.
(b)Fixedoverheadisallocatedbasedonthe
normalcapacityoftheproductionfacilities.
Normalcapacityistheproductionexpectedtobe
achievedoveranumberofperiodsorseasons
undernormalcircumstances,takingintoaccount
thelossofcapacityresultingfromplanned
maintenance.Answer(a)isincorrect,becausethe
actualamountofproductionmayonlybeusedif
itapproximatesnormalcapacity.Answers(c)
and(d)areincorrectbecausetheaccounting
standardsdonotspecifyaformulatocalculate
normalcapacity.
10. (d)Normalcapacityreferstoarangein
productionlevelsthatwillvarybasedon
businessandindustryspecificfactors.Normal
capacityistheproductionexpectedtobe
achievedoveranumberofperiodsorseasons
undernormalcircumstances,takingintoaccount
thelossofcapacityresultingfromplanned
maintenance.Answer(a)isincorrectbecausethe
Codificationdoesnotspecifyaformulafor
calculatingnormalcapacity.Answers(b)and(c)
areincorrectbecauseactualproductionmay
onlybeusedifitapproximatesnormalcapacity.
11. (c)Unallocatedfixedoverheadcostsare
recognizedasanexpenseintheperiodinwhich
theyareincurred.Therefore,answers(a),(b),
and(d)areincorrect.
12. (a)Anyabnormalcostsforfreight,handling
costs,andwastedmaterialarerequiredtobe
treatedascurrentperiodcharges,andnotapart
ofinventorycost.Therefore,answers(b),(c),
and(d)areincorrect.
13. (c)Inventoriablecostsincludeallcostsnecessaryto
347
preparegoodsforsale.Foramerchandisingconcern,these
includethepurchasepriceofthegoods,freightin,
insurance,warehousing,andanycostsnecessarytogetthe
goodstothepointofsale.Abnormalfreightandhandling
shouldbechargedtoexpenseoftheperiod.Therefore,the
normalcostsforinventoryare$5,500($3,000+$2,000+
$500)andtheabnormalfreightof$1,200ischargedto
currentexpenseoftheperiod.
B. InventoryValuationandCostFlowMethods
14. (d)EndinginventoryatdollarvalueLIFO
iscalculatedasthebaseyearinventorytimesthe
index.Therefore,theindexusedcanbe
calculatedas2.00=($80,000EIatdollarvalue
LIFO/$40,000baseyearcost).
15. (b)Theinventoryvaluationsarecalculatedasfol
lows:
ValuationsofendinginventoryunderLIFOperpetual
1,400unitsat$1.00
800unitsat$5.00
Total
=
=
$1,400
4,000
$5,400
ValueofendinginventoryunderLIFOperiodic
2,000unitsat$1.00
200unitsat$3.00
Total
B.2.
=
=
$2,000
600
$2,600
WeightedAverage
16.(b)Therequirementistodeterminewhether
theweightedaverageinventorymethodisapplicabletoa
periodicand/oraperpetualinventorysystem.The
weightedaveragemethodcomputesaweightedaverage
unitcostofinventoryfortheentireperiodandisusedwith
periodicrecords.Themovingaveragemethodrequiresthat
anewunitofcostbecomputedeachtimenewgoodsare
purchasedandisusedwithperpetualrecords.
B.4.
MovingAverage
17.(b)Themovingaveragemethodrequiresthata
newunitcostbecomputedeachtimegoodsarepurchased.
Thenewunitcostisusedtocostallsalesofinventory
untilthenextpurchase.Afterthe1/7/11purchase,Metro
owns1,600units(1,000+600)atatotalcostof$2,800
($1,000+$1,800).Therefore,themovingaverageunit
costatthattimeis$1.75($2,8001,600units).Afterthe
1/20/11saleof900units(ataunitofcostof$1.75),Metro
owns700unitsataunitcostof$1.75(700$1.75=
$1,225).The1/25/11purchaseof400unitsatatotalcost
of$2,000increasesinventorytoits1/31/11balanceof
$3,225($1,225+$2,000).Thenewunitcost(notrequired)
is$2.93($3,2251,100).
B.5.
LowerofCostorMarket
18.(c)Thelowerofcostormarket(LCM)isused
forfinancialreportingofinventories.Themarketvalueof
inventoryisdefinedasthereplacementcost(RC),aslong
asitislessthantheceiling(netrealizablevalue,orNRV)
andmorethanthefloor(NRVlessanormalprofit,orNRV
NP).Inthiscase,theamountsare
Ceiling:NRV=$40,000est.sell.price
$12,000disp.cost=
Floor:NRVNP=$28,000(10%$40,000)
RC:
$28,000
$24,000
$20,000
SinceRCfallsbelowthefloor,thefloor(NRVNP)is
thedesignatedmarketvalue.Oncemarketvalueis
designated,LCMcanbedeterminedbysimply
determiningthelowerofcost($26,000)ormarket
($24,000).Therefore,inventoryisreportedat$24,000.
19.(a)SFAC5establishesfivedifferentattributes
onwhichassetscanbemeasured.Theattributeused
shouldbedeterminedbythenatureoftheitemandthe
relevanceandreliabilityoftheattributemeasured.The
fiveattributesarehistoricalcost,currentcost,current
marketvalue,netrealiz
MODULE10INVENTORY
348
ablevalue,andpresentvalue.
Historicalcostisdefinedasthe
amountofcash,oritsequivalent,paid
toacquireanasset.Reporting
inventoryatlowerofcostormarketis
adeparturefromthehistoricalcost
principleastheinventorycould
potentiallybecarriedatthemarket
valueiflower.Although,reporting
inventoryatlowerofcostormarket
doesnotcreateadeparturefrom
conservatismasthismethodcarriesat
inventorythelowestormost
conservativevalue.TheuseofLCM
doesnotviolatetheprincipleof
consistencyeither,asitwouldbe
reportedonthisbasiscontinually.
FinallytheuseofLCMwouldnot
violatetheprincipleoffulldisclosure
asitsusewouldbediscussedinthe
footnotes.
20.(d)Inventoryistobevaluedat
thelowerofcostormarket.Under
thismethod,marketisreplacement
costprovidedthatreplacementcost
islowerthannetrealizablevalue
(ceiling)andhigherthannet
realizablevaluelessthenormal
profitmargin(floor).Thequestion
doesnotspecifywhether
replacementcostisaboveorbelow
netrealizablevalue,butsincethe
originalcostisbelowbothofthese
values,thatinformationis
irrelevant.
NRV/RC
OC
NRV NP
EitherNRVorRCwillbe
designatedasthemarketvalueof
theinventory,andsincetheoriginal
costisbelowbothofthesevalues,
theinventorywillbevaluedatits
originalcost.Answer(c)isincorrect
becauseNRVNPrepresentsthe
marketfloor.Answers(a)and(b)
areincorrectbecausetheyareboth
abovetheoriginalcost.
21.(b)Lowerofcostormarket
(LCM)isusedforfinancialreporting
ofinventories.Themarketvalueof
inventoryisdefinedasthe
replacementcost(RC)aslongasitis
lessthantheceiling(netrealizable
value,orNRV)andmorethanthe
floor(NRVlessanormalprofit,or
NRVNP).Therefore,ifinventoryis
reportedatRC,RCmustbelessthan
originalcost(meaningstatementIis
notcorrect),andRCmustbelessthan
NRV(meaningstatementIIis
correct)andgreaterthanNRVNP.
22.(b)Inventoryispricedatmarket
whenmarketvalueislessthancost.
Marketvalueisdefinedascurrent
replacementcost,subjecttoa
ceilingofnetrealizablevalue(NRV)
andafloorofnetrealizablevalue
minusanormalprofitmargin.
OriginalCost
NetRealizableValue
(NRV)
NRVNormalProfit
ReplacementCost
Inthissituation,replacementcost
liesoutsideof(below)thefloorand
ceilinglimitations.Therefore,NRV
lessanormalprofitmargin(the
floor),willbeusedasthemarketto
determineLCM.Sinceoriginal
costisgreaterthanmarket,market
willbeusedtopricetheinventory
fortheperiod.
B.6.LossesonPurchase
Commitments
23.(c)Therequirementisto
determinetheamountofprobableloss
fromthepurchasecommitmentthat
Cardshouldreportinits2011income
statement.Whenthereisadeclinein
marketvaluebelowthecontractprice
atthebalancesheetdateandthe
contractisnoncancelable,an
unrealizedlossshouldberecordedin
theperiodofdeclineandreportedin
theincomestatement.Inthiscase,
Cardhasacontracttopurchasea
minimumof100,000unitsbothin
2012and2013at$.10perunit.The
$20,000loss(200,000$.10)on
theseobsoleteunitsshouldbe
reducedbytheamountCardbelieves
isrealizablefromthesaleofthese
units.Therefore,thelosson
purchasecommitmentis$16,000
[$20,000(200,000
.02)].Additionally,CardCorp.would
needtorecordalossof$20,000($.08
250,000)frominventory
obsolescence.
24.(a)Tomaximizeitsinventory
carryingamountatDecember31,
2011,Threadshouldusethe
perpetualmovingaveragemethod
withthelowerofcostormarketrule
appliedtothetotalinventory.First,
whenusingtheperpetualmoving
averagemethod,thecostofsales
throughouttheyeararedetermined
usingtheaveragecostofpurchases
uptothetimeofthesale.Onthe
otherhand,undertheperiodic
weightedaveragemethod,thecost
ofeachitemistheweightedaverage
ofallunitspurchasedduringthe
year.Duringaperiodofrising
prices,theperpetualmovingaverage
methodresultsinalowercostof
goodssoldandahigherending
inventorybecausethecostofitems
soldthroughouttheyearisthe
averageoftheearlier,lowerprices.
Second,theapplicationofthelower
ofcostormarketruletothetotal
inventorywillresultinahigher
endinginventorybecausemarket
valueslowerthancostareoffset
againstmarketvalueshigherthan
cost.
B.7.&B.8.FirstIn,FirstOut
(FIFO),andLastIn,
FirstOut(LIFO)
25. (c)Therequirementisto
determinethecostofthe
1/31/11inventory,usingthe
LIFOmethod.LIFOstands
forlastin,firstout;this
meansthatthecostofthe
unitspurchasedmost
recentlyareincludedincost
ofgoodssold.Therefore,
the1/31/11inventory
consistsofthe250unitsthat
werepurchasedatthe
earliestdate(s).Thus,the
1/31/11inventorywould
consistofthe150unitson
handat1/1/11(150$21=
$3,150)plusanadditional
100unitspurchasedatthe
earliestpurchasedatein
January(January10;100
$22=$2,200).Thetotal
valueoftheinventoryat
1/31/11wouldbe$5,350
($3,150+$2,200).
26. (b)LIFOstandsforlastin,
firstout;thismeansthatitis
assumedthatanyunitssold
aretheunitsmostrecently
purchased.Inaperpetual
system,LIFOisappliedat
thetimeofeachsalerather
thanonceayearasina
periodicsystem.Using
LIFO,the900unitssoldon
1/20/11wouldconsistofthe
600unitspurchasedon
1/7/11and300ofthe1,000
unitsinthe1/1/11balance.
Thiswouldleavein
inventory700unitsfromthe
1/1/11balance.Afterthe
1/25/11purchase,inventory
includedthose700units
plusthe400unitspurchased
on1/25/11.Therefore,
endinginventoryis$2,700
[(700$1)+(400$5)].
27. (d)Whenacompanyuses
LIFOforexternal report
ing purposes and another
inventory method for
internalpur
poses,aLIFOReserveaccountis
usedtoreduceinventoryfromthe
internalvaluationtotheLIFO
valuation.LIFOReserveisacontra
accounttoinventory,andisadjusted
upor
MODULE10INVENTORY
downatyearendwitha
correspondingincreaseordecreaseto
CostofGoodsSold.Inthiscase,the
LIFOReserveaccountmustbe
adjustedfromabalanceof$35,000to
abalanceof$55,000($375,000
$320,000).Therefore,LIFOReserve
iscreditedfor$20,000($55,000
$35,000)withacorrespondingdebit
toCostofGoodsSold.
28. (c)InachangetoLIFO,no
recognitionisgiventoany
cumulativeeffectassociated
withthechangebecauseitis
usuallynotdeterminable.
Thus,theeffectonendingin
ventoryandnetincomeisthe
resultsolelyofcurrentyear
effects.Inaperiodofrising
prices,LIFOwillresultina
lowerendinginventory
amountthanFIFObecause
theearlierlowercostsare
assumedtoremaininending
inventory.LIFOwillalso
resultinalowernetincome
becausethemorerecent
highercostsareassignedto
costofgoodssold.
29. (a)Theinventorycostingmethod
whichmostcloselyapproximatesthe
currentcostforcostofgoodssoldis
LIFO,whilethemethodwhichmore
accuratelyreflectsendinginventoryis
FIFO.UnderLIFO,themostrecent
purchasesareassumedtobethefirst
goodssold;thus,costofgoodssold
containsrelativelycurrentcosts.On
theotherhand,sinceFIFOassumes
thatthegoodsfrombeginning
inventoryandtheearliestpurchases
aresoldfirst,theendinginventoryis
madeupofmorerecentpurchases
andthusrepresentsamorecurrent
value.
30. (a)UndertheFIFOmethod,thefirst
goodspurchasedareconsideredtobe
thefirstgoodsusedorsold.Ending
inventoryisthusmadeupofthelatest
(mostrecent)purchases.Whenever
theFIFOmethodisused,theending
inventoryisthesamewhethera
perpetualorperiodicsystemisused.
Thisistrueevenduringperiodsof
risingorfallingpricesbecausethe
inventoryflowisalwaysin
chronologicalorder.UndertheLIFO
method,thelatest(mostrecent)pur
chasesareconsideredtobethefirst
goodsusedorsold.Endinginventory
isthusmadeupofthefirst(oldest)
purchases.Whenaperiodicmethod
349
isused,thefirst/lastpurchase
determinationismadeonlyattheend
oftheyear,basedupontheactual
chronologicalorderofallpurchases.
Whenaperpetualmethodisused,
however,thefirst/lastpurchase
determinationismadecontinuously
throughouttheyear.Wheninventory
levelsgetlowundertheperpetual
method,earlypurchasecostswill
oftenbeassignedtogoodssold,a
situationthatismuchlesslikelyto
occurinaperiodicsystem.Therefore,
intimesofeitherrisingorfalling
prices,LIFOendinginventoryis
usuallydifferentunderaperiodic
systemthanunderaperpetualsystem.
B.9.
DollarValueLIFO
31.(c)Whenusingdollarvalue
LIFO,theendinginventoryat
currentyearcostmustfirstbe
convertedtobaseyearcost.This
amountisgivenat12/31/11
($230,000),butitcouldbecomputed
asfollows:$276,0001.20=
$230,000.Thenextstepisto
determinetheincrementalLIFO
layersatbaseyearcost.The1/1/10
(baseyear)layeris$150,000,the
2010layeris$50,000($200,000
$150,000),andthe2011layeris
$30,000($230,000$200,000).
Finally,theLIFOlayersarerestated
usingthepriceindexineffectatthe
timeeachlayerwasadded.
1/1/10layer
2010layer
2011layer
Basecost
$150,000
50,000
30,000
$230,000
Endinginventory
atDVLIFOcost
1.00=
$150,000
1.10=
55,000
1.20=
36,000
$241,000
32.(c)Whenusingdollarvalue
LIFO,theendinginventoryat
currentyearcostmustfirstbe
convertedtobaseyearcost.The
12/31/11inventoryatbaseyearcost
isgivenas$60,000.Sincethe
12/31/10inventoryatbaseyearcost
was$45,000($40,000baselayerand
$5,0002010layer),anewlayerof
$15,000wasaddedin2011($60,000
$45,000).Thislayermustbe
restatedusingthe2011priceindex.
The2011priceindexiscomputed
usingthedoubleextensiontechnique,
asillustratedbelow.
determinetheappropriate
useofendinginventoryat
currentyearcostand
endinginventoryatbase
yearcostincalculatingthe
dollarvalueLIFOindex.
Theindexnumberusedto
convertthecurrentyears
inventorylayeris
calculatedasfollows:
Endinginventory
atcurrentyearcost
Index
Endinginventory
atbaseyearcost
Thisindexindicatestherelationship
betweencurrentandbaseyearprices
asapercentage,andwhenmultiplied
EIatyearendprices
= $80,000 bythenewlayer(whichisthe
EIatbaseyearprices
$60,000
increaseininventoryinbaseyear
Therefore,the12/31/11inventory
dollars),itwillconvertthelayerto
usingdollarvalueLIFOis$66,000
currentdollars.
ascomputedbelow.
35.(c)Duringperiodsofrising
Basecost
prices,theinventorycostingmethods
Baselayer
$40,000
2010layer
5,000
whichwillgiveJonesthelowest
2011layer
15,000
1.33 endinginventorybalanceareLIFO
methods,becauseinventoryitemsthat
werepurchasedattheearliestdate
33. (b)Therequirementisto
(whenpriceswerelower)willremain
determinewhichinventory
ininventoryandthemostrecently
methodrequiresestimates
purchasedandmoreexpensiveitems
ofpricelevelchangesfor
willbeexpensedthroughcostof
specificinventories.In
goodssold.AnyFIFOmethodwill
accordancewiththedollar
produceahigherendinginventory
valueLIFOmethod,the
balanceduringinflationsincethe
endinginventoryisfirst
itemspurchasedearliest(atlower
convertedtothebaseyear
prices)willbeexpensedthrough
costsothattheincremental
CGS,whilethemoreexpensiveitems
layerscanbedetermined.
remainininventory.Answers(a)and
Theincrementallayersare
(b)areincorrectbecauseneitherwill
thenrestatedusingtheprice
giveJonesalowerendinginventory
indexwhichwasineffectat
balancethandollarvalueLIFO,
thetimeeachofthelayers
particularlyasJonesinventory
wereaddedtothe
changes(becausedollarvalueLIFO
inventory.Thus,the
allowstheLIFOlayerstobemade
specificlayersofthe
upofsimilar,notnecessarily
endinginventoryare
identical,items).
adjustedtothecurrentprice
level.Therefore,answer(b)
B.10.GrossProfit
iscorrect.Answers(a),(c),
and(d)areincorrect
36.(a)Thegrossprofitmethodcan
becausethesemethodsdo
beusedtoestimatethecostof
notspecificallyadjustfor
missinginventory.Thefirststepisto
pricelevelchanges.
computethecostofgoodsavailable
forsale.
34. (b)Therequirementisto
MODULE10INVENTORY
350
$120,000).
Beginninginventory
Purchases
Costofgoodsavailableforsale
Thesecondstepistoestimatecostof
goodssoldbasedonthegrossprofit
percentage.
Sales
Estimatedgrossprofit($3,200,00025%)
Costofgoodssold($3,200,00075%)
Notethatashortcutistorealizethat
ifgrossprofitis25%ofsales,costof
goodssoldmustbe75%ofsales.The
thirdstepistocomputeestimated
endinginventory.
Costofgoodsavailableforsale
Estimatedcostofgoodssold
Estimatedendinginventory
Sincetheactualcountofending
inventoryatDecember31was
only$575,000,theestimated
shortageininventoryis$25,000
($600,000$575,000).
B.14. CostApportionmentby
RelativeSalesValue
37.(c)Thetotalcostofacquiringthe
landandpreparingitforsale
($1,200,000+$300,000=
$1,500,000)shouldbeallocatedto
theresidentiallotsbasedontheir
relativesalesvalue,ascomputed
below.
Lot
class
A
B
C
Total cost
$1,500,000
#of
lots
100
100
200
Sales
price
$24,000
16,000
10,000
Fractionallocated
toClassA
($2,400/$6,000)
C. ItemstoIncludeinInventory
38. (d)Beforeadjustment,the
inventorybasedona
physicalcountwas
$1,500,000.The$90,000of
merchandiseshippedFOB
shippingpointbyavendor
on12/30/11shouldalsobe
includedinHercs12/31/11
inventorybecauseHerc,the
buyer,ownsthegoods
whileintransitunderthese
terms.Thegoodsinthe
shippingarea(cost,
$120,000)arealsoowned
byHercbecausetheywere
notshippeduntil2012and
Hercstillretainstherisks
ofownershipuntilthat
point.Therefore,12/31/11
inventoryis$1,710,000
($1,500,000+$90,000+
39. (a)Beforeadjustment,the
balanceintheAccounts
Payableaccountis
$2,200,000.The$40,000of
goodslostintransitfroma
vendorwereshippedFOB
shippingpoint.Thismeans
thebuyerownsthegoods
whiletheywereintransit;
therefore,Kewshould
recordthepurchaseandac
countspayablein2011.
Kew,notthevendor,is
ultimatelyresponsiblefor
thelostgoods(notethat
Kew,notthevendor,is
suingthecommoncarrier).
The$70,000returnthatwas
recordedon1/5/12should
havebeenrecordedin2011
whenthereturnwas
authorized(December27,
2011).Therefore,Kew
shouldreduce12/31/11
AccountsPayableby
$70,000.The$50,000of
goodsreceivedon1/6/12
wereproperlyrecordedin
2012,sincethetermswere
FOBdestination(thebuyer
doesnotownthegoods
untiltheyarephysically
received).Therefore,no
adjustmentisnecessaryfor
thisamount.Kewshould
report12/31/11Accounts
Payableat$2,170,000
($2,200,000+$40,000
$70,000).
40. (d)Netsalesis$2,300,000,
subjecttothreepossible
adjustments.Thegoods
returned($50,000)should
berecordedasareturnin
2011,whenLewis
authorizedthereturn.
Sincethisreturnwasnotrecorded
until2012,2011salesmustbe
adjusteddownward.Thegoods
shippedon12/30/11($80,000)were
recordedasasalein2012Sincethe
termswereFOBshippingpoint,the
salemustberecordedin2011when
thegoodswereshipped;therefore,
2011salesmustbeadjustedupward.
43.
Thegoodsshippedon1/3/12
($100,000)shouldnotberecordedas
asaleuntil2012.Sincethesalewas
recordedin2011,2011salesmustbe
adjusteddownward.Therefore,
adjustednetsalesfor2011shouldbe
$2,230,000($2,300,000$50,000+
$80,000$100,000).
41.(c)Generally,goodsare
consideredsoldwhenlegaltitletothe
goodspassestothebuyer.Incertain
situations,however,thetransferof
titlecriteriadoesnotreflectthe
underlyingeconomicsofthe
situation.Inthissituation,although
transferoflegaltitlemaynothave
occurredforthe500segregated
desks,theeconomicsubstanceofthe
transactionisthatthesellerno
longerretainstherisksofownership.
Therefore,all5,000desks(including
the500segregatedandaccepted
desks)areconsideredsoldin2011, 44.
andrevenueof$550,000is
recognized(5,000$110).Notethat
theamountofcashcollected
($450,000)doesnotaffectthe
amountofrevenuerecognizedinthis
case.
D. Consignments
$10,000(10$1,000).
Notethatthetrans
portationcosts($800)do
notaffectsaleseither;one
fourth(10/40)isreflected
incostofgoodssoldand
threefourths(30/40)is
includedinending
inventory.
(d)Noadjustmentisnecessaryforthe
goodsintransit($36,000).Thegoods
wereshippedFOBshippingpoint,
whichmeansthebuyer(Opal)owns
thegoodswhileintransit.Therefore,
Opalproperlyincludedthesegoodsin
12/31/11inventory.The
merchandiseoutonconsignmentis
ownedbytheconsignor(Opal)and
shouldbeincludedinOpals
inventoryatcost[$40,000(40%
$40,000)=$24,000].Therefore,
inventorymustbereducedby
$16,000forthisitem($40,000
$24,000).Thegoodsheldoncon
signment($27,000)areownedby
theconsignor,notOpal;therefore,
inventorymustbereduced$27,000
forthisitem.Thetotalreductionin
inventoryis$43,000($16,000+
$27,000).
(c)Altsold500oftheconsigned
sweaters(5055)at$100each,
resultingintotalsalesof$50,000
(500$100).Altmustreporta
payabletoToddforthisamount,less
Altscommission[$50,000(10%
$50,000)=$45,000].Altdoesnot
oweToddanythingfortheunsold
sweatersuntiltheyaresold.
MODULE10INVENTORY
46.(d)Inaconsignment,the
manufacturerorwholesaleris
referredtoastheconsignorandthe
dealerorretailerisreferredtoasthe
consignee.Insuchanarrangement,
titletothegoodsremainswiththe
consignoruntiltheyaresoldtoa
thirdparty.Jelspaymentof
reimbursablefreightcostsresultsin
anaccountreceivablefromDale,
whichJelwillsubtractfromthesale
proceedsitremitstoDale.An
swers(a),(b),and(c)areincorrect
becausetheconsignee,Jel,generally
doesnotbearanycostsassociated
withthesaleofconsignedgoods.
E. Ratios
47. (b) Theformulatocompute
thecurrentratiois
Currentratio=
Currentassets
Currentliabilities
Thefollowingentrieswouldbe
recordedwheninventoryissoldon
account:
Accountsreceivable
Salesprice
Sales
Costofgoodssold
ofmerchandise
Costof
Inventory
merchandise
Sincethesellingprice(increaseto
AR)isnormallyhigherthanthe
costofthemerchandisesold
(decreasetomerchandise
inventory)thesalewouldnormally
causeanetincreaseincurrent
assets,andtherefore,anetincrease
inthecurrentratio.Whenthe
existingcurrentratioisgreaterthan
one,increasesofequalamountsto
thenumerator(inventory,a
componentofcurrentassets)and
denominator(accountspayable,a
componentofcurrentliabilities)
willreducetheratio.Whenan
accountreceivableiscollected,cash
(acurrentasset)isincreasedbythe
sameamountthataccounts
receivable(anothercurrentasset)is
decreased.Thus,thetransactionhas
noimpactonthecurrentratio.
Whenmachinery(anoncurrent
asset)ispurchasedforcash(a
currentasset),thereisadecreasein
thecurrentratio.
48. (b)Theformulaforinventory
turnoveris
Costofgoods
sold
Average
inventory
Averageinventoryisequalto
beginninginventoryplusending
351
inventory,dividedbytwo.Since
beginninginventoryisnotgiven,it
mustbecomputedusingthecostof
goodssoldrelationship
+
Costofgoodssold
Endinginventory
Costofgoodsavailableforsale
Purchases
Beginninginventory
$900,000
180,000
$1,080,000
960,000
$ 120,000
Thus,ifcostofgoodssoldincreases
whileinventoryremainsunchanged,
thentheinventoryturnoverratiowill
increase.
Inaddition,wemustexaminethe
effectsoftheincreaseincostof
goodssoldonthegrossprofit
percentagewhensalesremain
constant.Assumingthesamefactsas
above,andsalesof$200,wegetthe
followingresults:
Sales
Costofgoodssales
Grossprofit
200
100
100
200
150
50
Thus,ascostofgoodssold
increases,thegrossprofitandthe
grossprofitpercentagewill
decrease.
Answer(a)isincorrectbecausea
decreaseincostofgoodssoldwill
causetheinventoryratiotoincrease.
Answers(b)and(c)areincorrect
becausetheyarenotrelatedto
inventoryturnover.
50.(b)Averagedayssalesin
inventorymeasuresthenumberof
daysinventoryisheldbeforesale;
itreflectsonefficiencyof
inventorypolicies.Itiscomputed
usingthefollowingformula:
365
Inventory
turnover
F.
LongTerm
Contracts
Construction
51.(a)Thetotalexpectedincome
onthecontractat12/31/11is
$900,000($9,000,000
$8,100,000).Theformulafor
recognizingprofitunderthe
percentageofcompletionmethod
is
Costtodate
Totalexpectedcosts
$6,300,000
$8,100,000
Expected
profit
$900,000
Thisresultisthetotalprofitonthe
contractin2010and2011.The2010
profitrecognizedmustbesubtracted
from$700,000todeterminethe2011
profit.At12/31/10,thetotalexpected
incomeonthecontractwas
$1,200,000($9,000,000
$7,800,000).Theincomerecognized
in2010was$600,000,ascomputed
below.
$3,900,000
$7,800,000
$1,200,000=
$600,000
Therefore,2011incomeis
$700,000less$600,000,or
$100,000.
52.(a)Profittoberecognized
usingthepercentageofcompletion
methodisgenerallycomputedas
follows:
Cost to date
Total expected cost
Expected
profit
Profit recognized
in previous periods
Notenoughinformationisgivenin
thisproblemtoperformthis
computation,so2011profitmustbe
computedindirectly.Sinceonly
constructionexpensesandprofitare
debitedtotheconstructionin
progress(CIPaccount),2010profit
musthavebeen$17,000($122,000
CIPless$105,000const.exp.).
Cumulativeprofitrecognizedbythe
endof2011mustbe$67,000
[$364,000CIPless$297,000
cumulativeconst.exp.($105,000+
$192,000)].Therefore,2011profit
was$50,000($67,000$17,000).
Therefore,averageinventoryis
$150,000[($120,000+$180,000)
2],andinventoryturnoveris6.0
times($900,000150,000).
49.(d)Thesolutionsapproachisto
createanumericalexamplethat
conformstothefactsgiveninthe
question.Theinventoryturnover
ratioiscalculatedasfollows:
Costofgoods
sold
Average
inventory
Ifweassumethatcostofgoodssold
hasincreasedfrom100to150and
average inventory has remained
unchangedat50thenthefollowing
ratiosresult:
Costofgoodssold
100
Averageinventory
50
=2
CIP
2010 Exp.
2010 Profit
2010 End.bal
2011 Exp.
2011 Profit
2011 End.bal.
105,000
?
122,000
192,000
?
364,000
2010Profit=$17,000
2011Profit=$50,000
MODULE10INVENTORY
352
53. (b)Basedonthe
informationgiven,itmust
beassumedthatcosts
incurredareusedto
measuretheextentof
progresstowardproject
completion.At12/31/10,
theprojectwas20%
completeandtotal
estimatedcostswere
$7,500,000.Therefore,costs
incurredasof12/31/10
were20%of$7,500,000,or
$1,500,000.At12/31/11,
theprojectwas60%
completeandtotal
estimatedcostswere
$8,000,000.Therefore,costs
incurredasof12/31/11are
60%of$8,000,000or
$4,800,000.Thecosts
incurredduring2011were
$4,800,000less$1,500,000,
or$3,300,000.
54. (b)Therequirementisto
determinetheamountof
losstorecognizein2011on
alongterm,fixedpricecon
structioncontract.Under
boththepercentageof
completionmethodandthe
completedcontractmethod,
anexpectedlossona
contractmustberecognized
infullintheperiodinwhich
theexpectedlossis
discovered.Therefore,
Hansonmustrecognizea
lossof$100,000in2011.
Coststodate
Totalestimatedcosts
Pellwouldrecognizegrossprofitof
$40,000onproject1
$240,000
$240,000+$120,000
56.(b)Constructioncompaniesthat
use the percentageofcompletion
methodinaccountingforlongterm
construction contracts usually
recognizegrossprofitaccordingto
thecosttocostmethod.
[$420,000($240,000+$120,000)]
Notethatprioryearsgrossprofit
neednotbesubtractedfrom$40,000
becausetheprojectcommenced
during2011.Underboththe
percentageofcompletionmethodand
thecompletedcontractmethod,an
expectedlossmustberecognizedin
fullintheperiodinwhichthe
expectedlossisdiscovered.Project2
hasanexpectedlossof($20,000)
[$300,000($280,000+$40,000)]
whichmustberecognizedinfullin
2011.Thenetgrossprofitrecognized
onthetwoprojectsis$20,000
($40,000profitless($20,000)loss.
57.(a)Inthefinalyearofacontract
accountedforbythepercentageof
completionmethod,thepercentageof
completionis100%,sincecoststo
dateequaltotalcosts.Therefore,the
formulatocalculateincometobe
recognizedinthefinalyearissimply
Expectedcontractrevenue
Expectedcontractcosts($930,000+$2,170,000)
Expectedloss
Estimatedprofit=Grossprofittodate
Inc
om
e
pre
vio
usl
y
=$40,000
particularyear.Theformulato
calculatecurrentincomeisas
follows:
Cost to date
Total expected cost
Expected
profit
Progressbillingsdonotimpactthe
amountofincomerecognized.
59.(a)Therequirementisto
determinetheratiotobeusedto
calculateincomeinthethirdyear
usingthepercentageof
completionmethod.Incomemay
berecognizedonacosttocost
basiswhenthepercentageof
completionmethodisused.
Cost to date
Total expected cost
Expected
profit
Answers(b)and(d)areincorrect
becausebillingstodatearenotused
asabasisforrecognizingrevenues.
Answer(c)isincorrectasthecostto
costcalculationrequiresacumulative
calculationsochangesinexpected
costsandexpectedincomecanbe
adjustedfor;thus,costsincurredin
yearthreewouldbeanincorrectbasis
forrecognitionofincome.
60. (d)Ananticipatedlossonalongterm
contractshouldberecognized
immediatelyunderboththe
percentageofcompletionandthe
completedcontractmethods.
61. (a)Therequirementisto
determinetheproperclas
sificationfortheprogress
billingsoncontractsaccount
underthepercentageof
completionmethod.Inthe
constructionindustry,
operatingcyclesfor
constructioncontracts
generallyexceedoneyear.
Therefore,thepredominant
practiceistoclassifyall
contractrelatedassetsand
(Contract price
Actual costs)
r
e
Actual
income
Thereforebothactualtotalcosts
andincome
previouslyrecognizedareusedin
calculatingincome.
58.(b)Underthepercentageof
completionmethodofaccountingfor
longtermcontracts,thecosttocost
formulaisusedtocomputethe
amountofincometoberecognizedin
a
liabilitiesascurrent.Onthe
balancesheet,the
ConstructioninProgress
(CIP)accountisnettedwith
thecontraaccount,progress
billings.IfCIPexceeds
billings,theexcessis
reportedasacurrentasset
[answer(a)].Ifbillings
exceedCIP,theexcessis
reportedasacurrent
liability.Answers(b)and
(c)areincorrectbecausethe
accountsrelatedto
constructioncontractsare
classifiedascurrent.
Answer(d)isincorrect
becauseprogressbillingsis
notusedasabasisfor
recognizingrevenues.
G. International
Financial
ReportingStandards(IFRS)
62. (c)Therequirementisto
calculatetheamountthat
shouldbepresentedforinventory.
Answer(c)iscorrectbe
causethelowerofcostornetrealizable
valuemethodrequires
netrealizablevaluetobecalculatedas
theestimatedselling
pricelessestimatedcostsofcompletion
andestimatedcoststo
sell.Therefore,theNRVis$850
($900$50).Thelowerof
costornetrealizablevalueis
determinedbycomparingthe
costof$1,000totheNRVof$850,
andusingthelower
amount.Inventoryshouldbereported
at$850.
63. (c)Therequirementisto
determinetheamountthat
shouldbereportedasinventory.
Answer(c)iscorrectbe
causeunderIFRSinventoryis
reportedatthelowerofcostor
netrealizablevalue.Therefore,the
amountis$90,000,which
isthelowerof$100,000costor
$90,000netrealizablevalue.
64. (c)Therequirementisto
identifytheinventoryitems
thatarenotvaluedatthelowerofcostornetrealizablevalue
underIFRS.Answer(c)iscorrect
becausebiologicalinven
toryitemsarevaluedatfairvalue
lessthecosttosellatthe
pointofharvest.
MODULE10INVENTORY
65. (c)
Th
e
re
qu
ire
m
en
t
is
to
id
en
tif
y
w
he
n
th
e
sp
ec
ifi
c
id
en
tif
ic
ati
on
m
et
ho
d
is
re
qu
ire
d
un
de
r
IF
R
S.
A
ns
w
er
(c)
is
co
rre
ct
be
ca
us
e
th
e
sp
ec
ifi
c
353
id
en
tif
ic
ati
on
m
et
ho
d
is
re
qu
ire
d
fo
r
in
ve
nt
or
y
ite
m
s
th
at
ar
e
no
t
int
er
ch
an
ge
ab
le
an
d
go
od
s
th
at
ar
e
pr
od
uc
ed
an
d
se
gr
eg
at
ed
fo
r
sp
ec
ifi
c
pr
oj
ec
ts.
66. (b
)
T
he
re
qu
ir
e
m
en
t
is
to
de
te
r
m
in
e
th
e
va
lu
e
of
th
e
in
ve
nt
or
y
ite
m
un
de
r
IF
R
S.
A
ns
w
er
(b
)
is
co
rr
ec
t
be
ca
us
e
un
de
r
IF
R
S,
in
ve
nt
or
y
is
pr
es
en
te
d
at
th
e
lo
w
er
of
co
st
($
1,
20
0)
or
ne
t
re
ali
za
bl
e
va
lu
e
($
1,
30
0
se
lli
ng
pr
ic
e
$1
50
es
ti
m
at
ed
co
m
pl
eti
on
an
d
se
lli
ng
co
st
s).
T
he
re
fo
re,
th
e
ite
m
sh
ou
ld
be
va
lu
ed
at
$1
,0
50
.
67. (d)
The
requ
ire
men
tis
to
iden
tify
the
stat
eme
nt
that
is
not
corr
ect
abo
ut
acc
ount
ing
for
inve
ntor
ies
und
er
IFR
S.
An
swe
r(d)
is
corr
ect
bec
ause
inve
ntor
ies
are
not
alw
ays
valu
ed
at
net
reali
zabl
e
valu
e.
The
y
are
valu
ed
at
the
low
er
of
cost
or
net
reali
zabl
e
valu
e.
68. (a)
The
req
uire
me
nt
is
to
ide
ntif
y
the
met
hod
of
ac
cou
ntin
g
that
is
not
allo
wed
und
er
IFR
S.
Ans
wer
(a)
is
cor
rect
bec
aus
e
the
LIF
O
met
hod
is
not
allo
wed
354
und
er
IFR
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MODULE10INVENTORY
SOLUTIONSTOSIMULATIONS
TaskBasedSimulation1
Concepts
Authoritative
Literature
Help
Included
Notincluded
1. Merchandisepurchasedforresale
2. Freightout
3. Directmaterials
4. Salesreturns
5. Packagingforshipmenttocustomer
6. Factoryoverhead
7. Interestoninventoryloan
8. Purchasediscountsnottaken
9. Freightin
10. Directlabor
Explanationofsolutions
7.
1.
Merchandisepurchasedforresaleisapartofinventory.
2.
Freightoutispartofsellingexpense.
3.
Directmaterialsarepartofworkinprocess,whichisaninventoryaccount
formanufacturers.
4.
Salesreturnsareacontraaccounttosales,andarenotpartofinventory.
5.
Packagingforshipmenttocustomerispartofsellingexpenses.
6.
Factoryoverheadispartofworkinprocess,whichisaninventoryaccount
formanufacturingfirms.
Interestoninventoryloanisanoperatingexpense.Interestcostshouldnotbe
capitalizedforassets thatare inuseorreadyfortheirintendeduseinthe
earningsactivitiesoftheenterprise.
8.
9.
10. Directlaborispartofworkinprocess,andisaninventoryaccountfor
manufacturingfirms.
TaskBasedSimulation2
JournalEntries
Authoritative
Literature
1.
Help
OnJanuary5,2011,purchased$17,000ofgardentillerson
account from Bestbuilt Tillers, terms 2/10, n/30, FOB
destination.Freightchargeswere$200.
Purchases
Accountspayable
17,000
17,000
2.OnJanuary10,2011,returnedgardentillersworth$2,000toBestbuilt
Tillersduetodefects.
Accountspayable
Purchasereturns
2,000
2,000
3.OnJanuary14,2011,paidfortheremainingtillerspurchasedin1.
Accountspayable
Purchasediscounts
Cash
*
15,000.02=300
15,000
300*
14,700