Completing the Audit and Post-audit Responsibilities

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CHAPTER 9 I
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Completing the [:
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Audit and Post-audit :
Responsibilities
ANALYTICAL PROCEDURES
1. Analytical procedures used in the overall review stage of the

audit generally include
A. Retesting controls that appeared to be ineffective during
the assessment of control risk.
B. Considering unusual or unexpected account balances
that w~re not_ previously identified. at
C. Gathering evidence concerning account balances th
have no~ changed from the prior year. e·
D. Performing tests of transactions to corroborate mana9
ment's financial stat,ement assertions.
· shallf
PSA 520 (Analytical Procedures) states, "The auditor
0
design and perform analytical procedures near the end
9 completing the Audit and Post-audit Responsibilities 633
cHAprER
the audit that assist the auditor when forming an overall

onclusion as to whether the financial statements are con-
esistent with t h e au ct·1tor's understanding of the entity."
Analytical procedures used in the final review stage of t;he

audit are intended to corroborate the conclusions formed
during the audit of individual components or elements of
the financial statements. They assist in arriving at the over-
all conclusion as to the reasonableness of the financial
statements. Moreover, analytical procedures may also iden-
tify a previously unrecognized risk of material misstatement.
Analytical procedures applied as an overall review in the

completion stage of the audit typically include reading the
financial statements and accompanying notes and conside r-
ing:
1) unusual or unexpected account balances or relation-
ships that were not previously identified; and
2) the adequacy of evidence regarding pr~viously iden-
tified unusual or unexpected balances.
Answer A is incorrect b~cause analytical procedures are not

tests of controls.
Answer C is incorrect because there may be nothing unusual

or unexpected concerning account balances that have not
changed from the prior year.
Answer D is incorrect because analytical procedures are not

tests of transactions.
2. Analytical procedures performed in the overall review stage

of an audit suggest that several accounts have unexpected
634 CPA EXAMINATION REVIEWER: AUDITING THEORY
relationships. The results of these procedures most likely

indicate that
A. The communication with the audit committee should be
revised.
B. Irregularities exist among the relevant account balances.
C. Additional substantive tests of details are required.
D. Internal control activities are not operating effectively.
The auditor should perform analytical procedures in the fi-

nal review stage of the audit in order to assess the conclu-
sions reached and evaluate the ·overall financial statement
presentation.
When analytical procedures disclosed significant fluctua-

tions or relationships that are inconsistent with other rele-
vant information or that deviate from predicted amounts,
the auditor is required to investigate and obtain adequate
explanations and appropriate corroborative evidence. Thus,
additional tests of details are required to be performed.
The auditor's investigation of unusual fluctuations begins

with inquires of management. In turn, the auditor will per-
form the following:
a) Corroboration of management's responses.
b) If management is unable to provide an explanation
or if the explanation is not considered adequate, the
auditor should consider the need to apply other au-
dit procedures based on the results of such inquiries.
Answer A is incorrect because the auditor should first ob·

tain explanations for 'the unexpected relationships to d~
termine if the communication with the audit committee will
be revised.
TER 9 Completing the Audit and Post-audit Responsibilities 635
~
Answer B is incorr~ct because it is the auditor's investiga-

tion, not the analytical procedures performed that may un-
cover the irregularities. '
Answer D is incorr:ct because the auditor performs tests of

controls, not analytical procedures, to determine the operat-
ing effectiveness of internal control activities.
RELATED PARTY TRANSACTIONS
3. The responsibility for the identification and disclosure of re-

lated parties and transactions with such parties rests with
the
A. Auditor
B. Entity's management
c. Financial Reporting Standards Council (FRSC)
o. Securities and Exchange Commission (SEC)
Management is responsible for the identification and disclo-
sure of related parties and transactions with such parties.
Management is required to implement adequate internal
control to ensure that related party transactions are appro-
priately identified in the information system and disclosed
in the finandal statements.
4. The auditor should review information provided by those

charged with governance and management identifying
I. The names of .all known related parties.
II. Related party transactions.
A. I only
B. II only
C. · Both I and II
D. Neither I nor II
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The auditor should review information provided by those

charged with governance and management identifying the
names of all known related parties and transactions with
such parties ..
5. Which of the following events most likely indicates the exist-

ence of related parties?
A. Making a loan without scheduled terms for repayment of
the funds.
B. Discussing merger terms with a company that is a major
competitor. .
C. Selling real estate at a price that differs significantly from
its book value.
D. Borrowing a large sum of money at a variable rate of in·
terest.
The following suggest related party transactions:
• Transactions which have abnormal terms of trade,

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~-'· ·- such as unusual prices, interest rates, guarantees,
and .repayment terms.
• Transactions which lack an apparent logical business
reason for their occurrence.
• Transactions in which substance differs from form .
• Transactions processed in an unusual manner.
• H1g · ·r·1cant transac t"10ns with certain
. h vo l ume or s1gni
customers or suppliers as compared with others. .
• Unrecorded transactions such as the receipt or pro
vision of management services at no charge.
related
Answer B is incorrect because the parties become
only after the merger transaction has occurred.
.,t..pfER
cr-v·
Answer C is. i?correct. because usu~lly, the real estate's fair
value is significantly different from its book value.
Answer D is incorrect because large sums of money are

normally borrowed at variable rates of interest, particularly
Jong-term borrowings.
Which of the following would not necessarily be a related

6
· party transaction?
A. A purchase from another corporation that is controlled
by the corporation's chief shareholder.
B. A loan from the corporation to a major shareholder.
c. Sale of land to the corporation by the spouse of a direc-
tor.
o. A sale to another corporation with a similar name.
According to PAS 24 (Related Party Disclosures), a party is
related to an entity if:
a) Directly, or indirectly through one or more intermediar-

ies, the party:
i. controls, is controlled by, or is under common con-
trol with, the entity (this includes parents, subsidiar-
ies, and fellow subsidiaries);
ii. has an interest in the entity that gives it significant
influence over the entity; or
iii. has joint control over the entity;
b) The party is an associate of the entity;
c) The party is a joint venture in whi:ch the entity is a ven-
turer;
d) The party is a member of the key m·a nagement person-
nel of the entity or its parent;
, I I
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e) The party is a close member of the family of any individ-

ual referred to in (a) or (d);
t) The party is an entity that is controlled, jointly con-
trolled or significantly influenced by; or for which signif-
icant voting power in such entity resides with, directly
or indirectly, any individual referred to in (d) or (e); or
g) The party is a post-employment benefit plan for the
benefit of employees of the entity, or of any entity that is
a related party of the entity.
Two corporations having a similar name are not necessarily

related.
Answers A, B, and Care incorrect because these transactions

are considered related party transactions.
7. Which of the following procedures should be performed by

the auditor to determine the completeness of information
provided by those charged with governance and manage-
ment identifying the names of all known related parties?
I. Review prior year's working papers for names of known
related parties.
II. Inquire as to the affiliation of those charged with gov·
ernance and officers with other entities.
III. Review minutes of the meetings of shareholders and
those charged w~th governance.
A. I and II only
B. II and III only
C. I and III only
D. I, II, and III
PSA 550 (Related Parties) requires the auditor to revieW ind

formation provided by those charged with governance an
C~TER
management identifying. the. names of known related par-

ties. Moreover, the auditor 1s required to perform the fol-
lowing procedures to determine the completeness of such
information:
a) Review prior year's working papers for names of
known related parties.
b) Review the entity's procedures for identification of
related parties.
c) Inquire as to the affiliation of those charged with
governance and officers with other entities.
d) Review shareholder records to determine the names
of principal shareholders or, if appropriate, obtain a
listing of principal shareholders from the share reg-
ister.
e) Review minutes of the meetings of shareholders and
those ·charged with governance and other relevant
statutory records such as the register of directors'
interests.
f) Inquire of other auditors currently involved in the
audit, or predecessor auditors, as to their knowledge
of additional related parties.
g) Review the entity's income tax returns and other in-
formation supplied to regulatory agencies.
8. Which of the following statements concerning related party

transactions is correct?
A. In the absence of evidence to the contrary, related party
transactions' should be assumed to be outside the ordi-
nary course of business.
B. The audit procedures directed toward identifying related
party transactions should include considering whether
transactions are occurring but are not b~ing given proper
accounting recognition.
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640 CPA EXAMINATION RE-VIEWER: AUDITING THEORY
C. An auditor should determine whether a particular trans-

action would have occurred if the parties had not been
related.
D. An auditor should substantiate that related party transac-
tions were consummated on terms equivalent to those
that prevail in arm's-length transactions. ·
PSA 550 states that in examining the identified related party

transactions, the auditor should obtain sufficient appropri-
ate audit evidence as to whether these transactions have
be.en properly recorded and disclosed.
Answer A is incorrect because the existence of related par-

ties and transactions with such parties are considered ordi·
nary features of business.
Answer C is incorrect because, unless the transaction is rou-

tine, it is not ordinarily possible for the auditor to determine
whether a particular transaction would have occurred if the
parties had l)Ot been 'related.
Answer D is incorrect because related party transactions

need not be consummated on terms equivalent to those that
prevail in arm's-length transactions.
. should
9. An auditor searching for related party transact1o~s . to
obtain an understanding of each subsidiary's relationship
the total entity· because t bal·
A. This may permit the audit of intercompany accoun
ances to be performed as of concurrent dates., would
B. This may reveal whether particular transactions d
have taken place if the parties had not been rela~\~d to
C. The business structure may be deliberately desig
obscure related party transactions.
9 completing the Audit and Post-audit Responsibilities 64 1
ctli'prt:R
o. rntercompan~ tra nstatctions ~ay have been consummated

on terms equ1va 1en o arm s-length transactions.
While the existence of. related parties and transactions with

such parties are considered ordinary features of business,
he auditor should be aware of them because a related party
~ransaction ma~ be ~otivate? by other than ordinary busi-
ness considerat10ns hke. profit sharing or even fraud. Thus,
the auditor should consider the possibility that the business
structure may be deliberately· designed to obscure related
party transactions.
Answer A is incorrect because the auditor is not required to

conduct a concurrent audit.
Answer Bis incorrect because determining whether particu-

lar transactions would have occurred if the parties had not
been related is ordinarily not possible, except for routine
transactions.
Answer D is incorrect because related party transactions

need not be consummated on terms equivalent to arm's-
length transactions.
10,. After determining that a related party transaction has, in

fact, occurred, an auditor should
A. Obtain an understanding of the business purpose of the
transaction.
B. Substantiate that the transaction was consummated on
terms equivalent to an arm's-length transaction.
C. Add a separate paragraph to the auditor's report to ex-
plain the transaction.
D. Perform analytical procedures to .verify whether similar
transactions occurred, but were not recorded.
, 3
After identifying related party transactions, the auditor

should obtain sufficient appropriate audit evidence to de-
termine whether such transactions have been properly rec-
\ orded and disclosed. The auditor should become satisfied
about their purpose, nature, extent, and effect. Therefore,
the auditor should obtain an understanding of the business
purpose of an i_d entified rel~ted party transaction.
Answer B is incorrect because the auditor's primary concern

is to determine whether a related party transaction has
been properly recorded and disclosed, not whether such
transaction was consummated on terms equivalent to an
arm's-length transaction.
Answer C is incorrect because no modification of the report

is necessary if the related party transaction has been
properly recorded and disclosed. However, the auditor may
add an emphasis of matter. paragraph to the audit report to
emphasize that the entity has had significant related partY
transactions.
Answ~r D is incorrect because ·management is responsible

to ensure that related party transactions are appropriate!Y
identified in the entity's information system and disclosed 1 ~
the financial statements. Thus, the auditor is not responsi-
ble for undisclosed, unrecorded related party transactions.
11. Which of the following audit procedures is most likely to as·

sist an auditor in identifying ·related party transactions~ nee
A. Inspecting communications with law firms for evrde
of u_nre?orted contingent liabilities. . nsac·
B. Revrewrng accounting records for nonrecurring tra
tions recognized near the balance sheet date.
completing the Audit and Post-audit Responsibilities 643
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Retesting in_effective controls previously reported to the
C. audit committee.
sending second requests for unanswered positive con-
D. firmations of accounts receivable.
The following _a re examples of audit procedures which may

identify the ex1s~ence of related party transactions:
performing detailed tests of transactions and balances.
Reviewing minutes of meetings of shareholders and those
charged witb governance. ·
Reviewing accounting records for large or unusual transac-

tions or balances, paying particular attention to transactions
recognized at or near. the end of the reporting period.
Revi~wing confirmations of loans receivable and payable

and confirmations from banks. Such a review may indicate
guarantor relationship and other related party transactions.
Reviewing investment transactions, for example, purchase
or sale of an equity interest in a joint venture or other enti-
ty.
Answer A is incorrect because the purpose of inspecting

communications with law firms for evidence of unreported
contingent liabilities· is to identify potential litigation,
claims, and assessments that may require disclosure in.the
financial statements.
Answer C is incorrect because the auditor should not retest

ineffective controls previously reported to the audit com-
mittee.
644 CPA EXAMINATION REVIEWER: AUDrTING THEORY
Answer D is incorrect because confirmations of accounts re-

ceivable do not ·normally provide audit evidence about the
existence of related party transactions.
12. For a reporting entity that has participated in related party

transactions that are material, disclosure in the financlal
statements should include
A. A reference to deficiencies in the entity's internal control.
B. A statement to the effect that a transaction was con-
summated on terms equivalent to those that prevail in
arm's-length transactions.
C. The nature of the relationship and the terms and manner
of settlement.
D. Details of the transa.ctions within major classifications.
PAS 24 (Related Party Disclosures) provides that if an enti~

has participated in material related party transactions'. it
should disclose the nature of the relationship, informatwn
about the transaction, and outstanding balances neces~ary
for an understanding of the potential effect of the relation-
ship on the financial statements.
As a minimum, the disclosures should include:

The amount of the transaction. · d
h · terms an
• The amount of outstanding balances, t elf d the
conditions, whether secured or unsecured .. an rtle-
nature of the consideration to be provided in se
ment. 0
ut·
• Provision for doubtful accounts related to the
standing balances. pect
. ·ad in res
• The expense recognized dunng the pen .
. 1 t d parties.
of doubtfµl accounts due f rom 1 ea e
c~nip/eting the Audit and Post-audit Responsibilities 645
prER 9
ct!A
er A is incorrect because the company is not required
An 5W ke financial statement disclosures about its internal
to ma
control.
swer B is incorrect because a statement to the effect that
An ansaction was consummated on terms equivalent to
h se that preva1·1 m
a tr . arm ,s- Iengt h transactions is not re-
~u~red. This representation shall be made only if such terms
be substantiated.
can . .
Answer D is incorrect because there is no requirement to
segregate the transactions into major classifications.
sussEQUENT EVENTS REVIEW
p.s used in PSA 560 (Subsequent Events), the term "subse-

13
. quent events" refers to
1. Events occurring between the date of the financial
statements and the date of the auditor's report.
II. Facts that become known to the auditor after the date
of the auditor's report.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
According to PSA 560, the term "subsequent events" refers

to events occurring between the date of the financial state-
ments and the date of the auditor's report, and facts that be~
come known to the auditor after the date of the auditor's
report.
14. Which of the following statements best describes the "date

of the financial statements?"
:--:
A. The date on which those with the recognized authority

assert that they have prepared the entity's complete set
of financial statements, including th'e-.related notes, and
that they have taken responsibility for them.
B. The date that the auditor's report and audited financial
statements are made available to third parties.
C, The date of the end of the latest period covered by the
financial statements.
D.. The date on which the auditor has obtained sufficient
appropriate audit evidence on which to base the opinion
on the financial statements.
According to the standard, the date of the financial state-

ments is the date of the end of the latest period covered by
the financial statements.
Answer A is incorrect because it is the date of approval of

Answer B is incorrect because it is the date of issuance of

Answer D is incorrect because it is usually the date of the

auditor's report.
15. The auditor is required to perform procedures d~sign.ed ~

obtain sufficient appropria~e audit evidence to 1den~ify the
events that may require adjustment of, or disclosure in,
financial statements up to the
A. Date of the auditor's report.
B. Date of approval of the financial statements.
C. Date the financial statements are issued.
D. Date of the financial statements.
p1eting the Audit and Post-audit Responsibilities 647
~9 corn
c~pff
andard requires the auditor to perform procedures
roe. s:ed to obtain sufficient appropriate audit evidence
desig ll events up to the date of the auditor's report that may
t11at ~ e adjustment of; or disclosure in, the financial state-
rellutir have been identified.
rnen s
. h of the following procedures would an . auditor most
16. :::~ perform to ~btain evide.nce about the occurrence of
bSequent events.
su Inquiring as to whether any unusual adjustments were
A. made after the date -Of the financial statements.
confirming a sample of material accounts receivable es-
6
. tablished after the date of the financial statements.
c comparing the financial statements being reported on
: with those of the prior period.
o. Investigating personnel changes in the accounting de-
partment occurring after the date of the financial state-
ments.
The audit procedures to identify subsequent events ordinar-

ily include the following:
• Reviewing the entity's established procedures to iden-
tify subsequent events.
• Reading minutes of the meetings of shai:eholders, the
board of directors, and committees held subsequent to
the d.ate of the financial statements and inquiring
about matters discussed at meetings for which
minutes are not yet available.
• Reading the entity's latest available interim financial
statements, appropriate budgets and f<0recasts, and
other related management reports.
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• Inquiring, or extending previous oral or written in-

quiries, of the entity's lawyers concerning litigation
and claims.
• Inquiring of management as to whether any subse-
quent events have occurred which might affect the fi-
nancial statements. Examples of such inquiries are:
The current status of items that were accounted for
on the basis of preliminary or inconclusive data.
Whether new commitments, borrowings, or guar-
antees have been entered into.
Whether sales of assets have occurred or are
planned.
Whether the issue of new shares or debentures or
an agreement to merge or liquidate has been made
or is planned.
Whether .any assets have been appropriated by
government or destroyed, for example, by fire or
flood.
Whether there have been any developments re-
garding risk areas and contingencies.
Whether any unusual accounting adjustments have
been made or are contemplated.
JikelY to
Whether any events have occurred or are ri·
occur which will bring into question the appro~ne
ateness of the accounting policies adopt.ed byues·
entity, for example, events that may call int ~n.
0
'ti on the validity of the going concern assumptl

. ·vables 1·s
Answer Bis incorrect because confirmation of recei. state·
1
ordinarily performed before the date of the financia
men ts.
9 Completing the Audit and Post-audit Responsibilities 649
ctl/ifER
wer C is incorrect because 'comparison of the fina~cial

Ans b . d .
statements . emg reporte on ~Ith those of the prior period
. n analytical procedure that is performed in the planning
is a d.
stage of the au It.
Answer D is incorrec~ bec~use personnel changes occurring

after the date of the financial statements are not considered
significant subs~quent ~vent~ that will require adjustment
of, or disclosure m; the fmanc1al statements.
Which of the following procedures should an auditor ordi-

17. narily perform regarding subsequent events?
A. Review the cutoff bank. statements for several months
after the year-end.
B. compare the latest available interim financial statements
with the financial statements being audited.
c. Send second requests to the client's custorl')ers who
failed to respond to initial accounts receivable confirma-
tion requests.
D. Communicate material yveaknesses in internal control to
the client's audit committee.
An analytical procedure that is designed to identify subse-

quent events is comparison of the latest interim financial
statements with those statements being reported on.
Answer A is incorrect because the auditor reviews cutoff

bank statements (usually 7 to .10 days from the balance
sheet date) to verify year-end bank reconciliations.
Answer C is incorrect because confirMation of receivables

typically do not relate to the recording of subsequent
events.
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Answer D is incorrect because communicating material in-

ternal control weaknesses to the. audit committee is not a
subsequent events procedure.
18. An auditor is concerned with completing various phases of

the audit after the balance sheet date. This subsequent pe-
riod extends to the date of the
A. Delivery of the auditor's report to the client. ·
B. Auditor's report.
C. Final review of the audit working papers.
D. Public issuance of the financial statements.
The auditor is required to perform ·procedures designed to

identify all subsequent .events up to the date of the auditor's
report. Hence, the subsequent events period extends from
the date of the financial statements (i.e., the balance sheet
date) to the date of the auditor's report.
Answers A and D are incorrect because the delivery of the

auditor's report to the client and the public issuance of the
financial statements both occur later· than the date 0 f the
auditor's report
. d per-
Answe·r C is incorrect because the auditor is reqmre ~tor's
1
form subsequent events work up to the date of the au
re po.r t.
the audi·
19. Which of the following statements best express~ . IJeCOflle
tor's responsibility with respect to facts whi~h , rep¢
5
known t-0 the auditor after th~ date of the au~ito~ed?
but before the date the financial statements are 155 ts
A. The auditor should amend the ·financial staternen · .
completing the Audit and Post-audit Responsibilities 0 51
ct1Apf~R
9
f the facts discovered will materially affect the financial
13. ~tatemen~,the audit?r shou.ld. issue a new report which
contains either a qualtfi~ opinion or an adverse opinion.
fhe auditor should cons1de~ whether the financial state-
C. rnents need amen~ment, ~1scuss the matter with man-
agement, and consider taking actions appropriate in the
circumstances. .
o. fhe auditor should withdraw from the engagement.
pSA 560 (Subsequent Events) provides that the auditor does

t have any responsibility to perform procedures or make
n~y inquiry regarding the financial statements after the date
aof the auditors rep ort .
I
It provides further that during the period from the date of

the auditor's report to the date the financial statements are
issued, the entity's management has the responsibility to in-
form the auditor of facts which may affect the financial
statements.
If during that period the auditor becomes aware of a fact

which may materially affect the financial statements, he/she
should consider whether the financial statements need
amendment, discuss the matter with management, and take
the action appropriate in the circumstances.
Answer A is incorrect because, if necessary, the entity's

management, not the audito.r, should amend the financial
statements.
Answer B is incorrect because expressing a qualified opin-

ion or an adverse opinion is appropriate when management
does not amend the financial statements in circumstances
where the auditor believes they need to be amended and the
auditor's report has not been released to the entity. When

the auditor's report has been released to the entity, the au-
ditor would notify those persons ultimately responsible for
the overall direction of the entity not to issue the financial
statements and the auditor's report to third parties.
Answer D is incorrect because the discovery of facts after

the date of the auditor's report does not necessarily require
withdrawal from the engagement.
20. After issuing a report, an auditor has no obligation to make

continuing inquiries or per.form other procedures concerning
the audited financial statements, unless
A. Final determinations or resolutions are made of contin-
gencies that had been disclosed in the financial state·
ments.
B. Information about an event that occurred after the date
of the auditor's report comes to the auditor's attention.
C. The control environment changes after issuance of the
report.
D. Information, which existed . at the report date and maY
affect the report, comes to the auditor's attention.
PSA 560 provides that after the financial statements and the
auditor's report have been issued, the auditor has no obli~:~
tion to make any inquiry concerning such financial sta
men ts.
·sted at
But, if the auditor becomes aware of a fact which exi that
the date of the auditor's report and which, if known ~~tor's
date, may have . caused the auditor to rpodify the a~:ncial
report, the auditor should consider whether the ~~h Jlll!Il'
statements need amendment, discuss the matter wi
cHAP
TER 9 Completing the Audit and Post-audit Responsibilities 653
agement, and take the action appropriate in the circum-

stances.
Answers A an? Care incorrect because after the report is is-

sued, the ~u~1t~r has no responsibility to consider changes
in the entity s internal control or final determinations or
resolutions of contingencies.
Answer B is incorrect because the auditor does not have re-

porting responsibility for events that occurred after the date
of the report.
21. Which of the following events occurring after the issuance of

an auditor's report most likely would cause the auditor to
make further inquiries about the previously issued financial
statements?
A. A technological development that could affect the entity's
future ability to continue as a going concern.
B. The entity's sale of a subsidiary that accounts for 30°/o of
the entity's consolidated sales.
C. The discovery of information regarding a contingency
that existed before the financial statements were issued.
D. The final resolution of a lawsuit disclosed in the notes to
If, after the report has been issued, the auditor becomes
aware of a fact which existed at the report date and which, if
known at that date, may have caused the auditor to modify
the report, the auditor should consider whether the finan-
cial statements need revision, discuss the matter with man-
agement, and take actions appropriate in the circumstances.
Answers A and B are incorrect because the auditor has no

reporting responsibility for events occurring after the issu-
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ance of the auditor's report if such events would not affect

the report.
Answer D is incorrect because the auditor has no -responsi·

bility to monitor disclosed contingencies after the report is
issued.
22. After an audit report containing an unmodified opinion on a

client's financial statements was issued, the client decided to
sell the shares of a subsidiary that accounts for 30% of its
revenue and 25% of its net income. The auditor should
A. Describe the effects of this subsequently discovered in-
formation in a communication with persons known to be
relying on the financial statements.
B. Take no action because the auditor has no obligation to
make any further inquiries.
C. Determine whether the information is reliable and, if de-
termined to be reliable, request that revised financial
statements be issued.
D. Notify the entity that the auditor's report may no longer
be associated with the financial statements.
After the report has been issued, the auditor has no resp~n·
sibility to make any further or continuing inquiry regardin~
the financial statements covered by the report, unless fac
that may affect the report come to his/her attention.
ctions
Answers A, C, and D are incorrect because these a that
might be appropriate if the auditor had discovered facts
existed at the date of the report.
ASSESSMENT OF GOING CONCER~ ASSUMPTIO~

I rinciP1e
23. PSA 570 (Going Concern) states that a .fundamenta con· Pg
in the preparation of financial statements is the goin
R 9 completing the Audit and Post-audit Responsibilities 655
cHAPrE
cern assumptipn. Un?e~ thi~ assumption, an entity is ordi-
narily viewed .as contrnurng rn business for the foreseeable
tuture wit~ neither. the intention nor the necessity of liquida-
tion, ceasrng trading or seeking protection from creditors
pursuant to laws and reg~la~ions'. .The responsibility to make
an assessment of an entity s ab1hty to continue as a going
concern rests with the
A. Auditor
B. Entity's management
c. securities and Exchange Commission (SEC)
D. Entity's creditors
Under PAS 1 (Presentation of Financial Statements), man-

agement is required to make an assessment of an entity's
ability to continue as a going coricern.
24. Which of the following ·statements best describes the audi-

tor's responsibility concerning the appropriateness of the go-
ing concern assumption in the preparation of the financial
statements?
A. The auditor's responsibility is to make a specific assess -
ment of the entity's ability to continue as a going con-
cern.
B. The auditor's responsibility is to predict future events or
conditions that may cause the entity to cease to continue
as a going concern.
C. The auditor's responsibility is to consider the appropri-
ateness of management's use of the going concern as-
sumption and consider whether there are material uncer-
tainties about the entity's ability to continue as a going
concern that need to be disclosed in the financial state-
ments.
D. The auditor's responsibility is to give a guarantee in the
audit report that the entity has the ability to continue as
a going concern.
PSA 570 states that the auditor's responsibility is to consid-

er the appropriateness of management's use of the going
concern assumption in the preparation of the financial
statements, and consider whether there are material uncer-
tainties about the entity's ability to continue as a going con-
cern that need to be disclosed in the financial statements.
Answer A is incorrect because the entity's management is

required to make a specific assessment of the entity's ability
to continue as a going concern.
Answers B and D are incorrect because the auditor cannot

predict future events or conditions that may cause the entity
to cease to continue as a going concern. Hence, even if the
auditor's report does not make any reference to going con-
cern uncertainty, it cannot be viewed as a guarantee as to
the entity's ability to continue as a going concern.
25. Which of the following conditions or events most likely would

cause an auditor to have substantial dcrubt about an entity's
ability to continue as a going concern?
A. Cash flows from operating activities are negative.
B. Stock dividends replace annual cash dividends.
C. Significant related party transactions are pervasive.
D. Research and development projects are postponed.
PSA 570 gives the following examples of conditio~s. ~~

events which may give rise to business risks, that individ
ally or collectively, may cast significant doubt about the en-
tity's ability to continue as a going concern:
Financial
• Net liability or net current liability position .
g completing the Audit and Post-audit Responsibilities 657
ct-IApfER
• Fixed-term borrowings approaching maturity with-

out realistic prospects of renewal or repayment; or
excessive reliance on short-term borrowings to fi -
nance long-term assets.
• Indications of withdrawal of financial support by
debtors and other creditors.
• Negative operating cash flows indicated by historical
or prospective financial statements.
• Adverse key financial ratios.
• Substantial operating losses or significant deteriora-
tion in the value of assets used to generate cash
flows.
• Arrears or discontinuance of dividends.
• Inability to pay creditors on due dates.
• Inability to comply with the terms of loan agree-
ments.
• Change from credit to cash-on-delivery (COD) trans-
actions with suppliers.
• Inability to obtain financing for essential new prod-
uct development or other essential investments.
Operating
• Loss of key management personnel without re-
placement.
• Loss of a major market, franchise, license, or princi-
pal supplier.
• Labor difficulties or shortages of important supplies.
Other
• Non-compliance with capital or other statutory re-
quirements.
• Penaing legal or regulatory proceedings· against the
entity that may, if successful, result in claims that are
unlikely to be satisfied.
• - > ~::::: ;-_~-~· -· • -• .,._ - .. :~.;.:•.J :,._-;. ~ · :ni(1~1!&. "'1+ liililllltJ
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658 CPA EXAMINATION REVIEWER: AUDITING·THEORY
• Changes in legislation or government policy ex-

pected to adversely affect the entity.
Answer B is incorrect because payments of stock dividends

will not cause going concern problems since they do not re-
quire outflow of cash.
Answer C is incorrect because the auditor's concern with re-

spect to related party transactions is the adequacy of disclo·
sure in the financial statements.
Answer D is incorrect because postponing R&D projects will

not cast significant doubt about the entity's ability to con·
tinue as a going concern.
26. Which of the following audit procedures most likely would

assist an auditor in identifying conditions and events that
may Indicate substantial doubt about an entity's ability to
continue as a going concern? ts
A. Confirming with third parties the details of arrangernen
to maintain financial support. . rza·
1
B. Comparing the entity's depreciation and asset capita
tion policies to other entities in the industry._ utoff
C. Reconciling the cash balance per books with the c
bank statement and the bank confirmation. assets
D. Inspecting title documents to verify whether any
are pledged as collateral.
. edures ro
The auditor typically performs the following proc . nificllflt
identify conditions and e~~nts that ~iay cast s~~ng coo·
doubt about an entity's ab1hty to continue as a g
cern:
• Analytical procedures.
• Subsequent events review.
9 completing the Audit and Post-audit Rt:!sponsibilities 659
#pTER
• Review of compliance with debt and loan agree-

ments.
• Reading minutes of meetings .
• Inquiry of legal counsel.
• Confirmation with related and third parties of ar-
rangements for financial support. ·
Answer B is incorrect because comparing the entity's ac-

counting policie~ to other entities in the industry would not
provide evidence about the entity's continued existence.
Answer C is incorrect because bank reconciliation proce-

dures would be performed to test the existence of cash.
Answer D is incorrect because inspecting title documents to

verify whether any assets are pledged as collateral relates tq
disclosure, not going concern, issues.
21. Which of the following conditions or events most likely would

cause an auditor to have substantial doubt about an entity's
ability to continue as a going concern?
A. Restrictions on the disposal of principal assets are pre-
sent.
B. Usual trade credit from suppliers is denied.
c. Significant related party transactions are pervasive.
D. Arrearages in principal stock dividends are paid.
Denial of usual trade credit from suppliers· is an indication

that the entity is facing financia~ difficulties.
Answer A is incorrect because long-term debt agreements

ordinarily include restrictions on fhe disposal of principal
assets.
Answer C is incorrect because the existence of related party

transaction,s concerns disclosure, not going concern, issues.
Answer D is incorrect because the payment of stock divi-

dends in arrears does not indicate that the entity is finan-
cially distressed.
28. Which of the following audit procedures would most likely

assist an auditor in identifying conditions and events that
may indicate there could be substantial doubt about an enti-
ty's ability to continue as a going concern?
A. Confirmation of bank balances.
B. Confirmation of accounts receivable from major custom-
ers.
C. Reconciliation of interest expense with debt outstanding.
D. Review of compliance with terms of debt agreements.
The auditor's review of compliance with the terms of debt

agreements may reveal conditions of non-compliance be-
cause the entity is in weak financial condition.
Answers A, B, and Care incorrect because these procedures

a~e less effective if the auditor's objective is to identify con·
ditions or events that may cast significant doubt about the
entity's ability to continue as a going concern.
29. Harold, CPA, believes there is substantial doubt · about the
ability of Jersamtan Co. to continue as a going concern for a
reasona?le period of time. In evaluating Jersamtan's plan~
for dealing with the adverse effects of future conditions ~n
events, Harold most likely would consider, as a mitigating
factor, Jersamtan's plans to
A. Postpone expenditures for research and development
projects.
completing the Audit and Post-audit Responsibilities 661
cW'prt:R
9
purchase production facilities currently being leased from
13· a related party.
strengthen internal controls over cash disbursements.
c. Discuss with lenders the terms of all debt and loan
o. agreemen ts ·
he auditor believes that there are conditions or events
~f Jicating that substantial doubt exists about an entity's
'~·my to continue as a going concern, he/she should inquire
a/management concerning its plans to mitigate their ad-
~erse effects. For example, management's plans to dispose
f assets, borrow money or restructure debt, reduce or de-
~y expend~tures, or incr~ase capi.tal. ~he auditor should ob-
tain sufficient appropnate audit evidence that manage-
ment's plans are feasible and that the outcome of these
plans will improve the situation.
Answer 8 is incorrect because the purchase of production

facilities will worsen the company's weak finan.cial condi-
tion.
Answer C is incorrect because improvements in internal

control will not solve the company's going concern prob-
lems.
Answer Dis incorrect because discussion with lenders is not

a sufficient action to improve the situation.
30. Harry, CPA, believes there is substantial doubt about the

ability of Tansamjer Corp. to continue as a going concern for
a reasonable period of time. In evaluating Tansamjer's
plans for dealing with the adverse effects of future condi-
tions and events, Harry most likely would consider, as a mit-
igating factor, Tansamjer's plans to
=)
·-
A. Purchase equipment and production facilities currently

being leased.
B. Accumulate treasury shares at prices favorable to
Tansamjer's historic price range.
C. Negotiate reductions in- required dividends being paid on
preference shares.
D. Accelerate research and development projects related to
future products.
The auditor should inquire of management concerning its

plans to mitigate the adverse effects of identified conditions
or events indicating that a substantial doubt exists about an
entity's ability to continue as a going concern.
Tl}e auditor should consider management's plans to dispose

of assets, borrow money or restructure debt, reduce or de-
lay expenditures, and increase capital. Management's plans
to negotiate reductions in required dividends being paid on
preference shares are intended to increase capital.
Answers A, 8, and D are incorrect because leasing equip·

ment and production facilities, increasing capital, and post-
ponement of R&D projects would be mitigating factors.
31. When an auditor concludes that there is substantial doubt

about a continuing audit client's ability to continue as a go·
ing concern for a reasonable period of time, the auditor's re·
sponsibil~ty is to ·ent's
A. Consider the adequacy of disclosure about the ch
possible inability to continue as a goir.g concern: on
B. Issue a qualified or adverse opinion, depending u~ial
materiality, due to the possible effects on the finan
statements. ge-
e. Report to the client's audit committee that ma~
ment's accounting estimates may need to be adjust ·
leting the Audit and Post-audit Responsibilities 663
~ 9 comP
c#~
l'r · Reissue the prior year's auditor's report and add an em-
o. hasis of matter paragraph that sp_ecifically refers to
~ f.~ubstantial doubt" and ''going concern."
A S70 provides th~t if the use of the going concern as-
p~mption is app~opnate but a materia~ u.nc~rtain~y exists,
5
uditor considers wheth e r the entity s fmanc1al state-
the a
JTlents:
a) Adequately describe the principal events or condi-
tions that give rise to the significant doubt on the en-
tity's ability to continue in operation and manage-
ment's plans to deal with these events a nd condi-
tions; and
b) Disclose clearly that there is a material uncertainty
related to events or conditions which may cast sig-
nificant doubt on the entity's ability to continue as a
going concern, and, therefore, that it may be unable
to realize its assets and discharge its liabilities in the
normal course of business.
Answer B is incorrect because if adequate disclosure is

made in the financial statements, the auditor may still ex-
press an unmodified opinion. However, the auditor's report
should be modified by adding an emphasis of matter para-
graph that highlights the going concern issue.
Answer C is incorrect because the going concern issue is not

directly related to management's accounting estimates that
) '
may need adjustment.
Answer D is incorrect because there is no need to change

the prior year's audit report since the auditor does not in-
t - ... • • • o < - pO .. "1 , - •
tend to change his/her opinion on the prior year's financial

statements.
OBTAINING WRITTEN REPRESENTATIONS FROM MANAGEMENT
32. Under PSA 580 (Written Representations), the auditor is re-

quired to obtain audit evidence that management
I. Has fulfilled its responsibility for the fair presentation of
the financial statements in accordance with applicable
financial reporting framework.
II. Has provided the auditor with all relevant information
and access as agreed in the terms of the audit engage-
ment.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
According to PSA 580, the auditor shall request man~ged

ment to provide a written representation that it has fulfille
its responsibility for the preparation of the financial sta.te·
ments in accordance with the applicable financial report~ng
framework, including where relevant their fair presentation
as set out in the terms of the audit engagement.
The standard provides further that the audito.r shall request

management to provide a written representation that: . for·
• It has provided the auditor with all relevant in dit
· and access as agreed in the terms of the all
mat1on
engagement; and fleet·
• All transactions have been recorded and are re
ed in the financial statements.
ct!Ap1e:f{
date of the written representation shall be

33. fheAfter the date of the auditor's report.
A· After the date of approval of the entity's financial state-
s.men ts.
C Before the entity's financial statements are issued.
· AS near as practicable to, but not after the date of the
0
· auditor's report on the financial statements.
A purpose of a management representation letter is to re-

34.
duce ·b·1· f .
A. The poss1 11ty o a misunderstanding concerning man-
agement's responsibility for the financial statements.
6. The scope of an auditor's procedures concerning related
party transactions and subsequent events.
c. Audit risk to an aggregate level of misstatement that
could be considered material.
D. An auditor's responsibility to detect material misstate-
ments only to the extent that the letter is relied on.
The auditor is required to obtain written representations

from management concerning matters material to the finan-
cial statements when other sufficient appropriate audit evi-
dence cannot reasonably be expected to exist. According to
the standard, the possibility of misunderstandings between
the auditor and management is reduced when oral repre-
sentations are confirmed by management in writing.
Answers B, C, and D are incorrect because management's

written representations cannot be a substitute for other au-
dit evidence that _can be obtained by performing audit pro-
cedures.
35. When an audit is made in accordance with PSAs, the auditor

should always
A. Observe the taking of physical inventory on the balance

sheet date.
B. Obtain certain written representations from manage-
ment.
C. Employ analytical procedures as substantive tests to ob-
tain evidence about specific assertions related to account
balances.
D. Document the understanding of the client's internal con-
trol and the basis for all conclusions about the assessed
level of control risk for financial statement assertions.
PSA 580 requires the auditor to obtain certain written rep-

resentations from management. They confirm oral repre-
sentations-either unsolicited or in response to specific in-
quiries-received from management.
Answer A is incorrect because attendance at the physical in-

ventory taking can be performed either during or after the
end of the period covered by the audit like when wel\-k~pt
perpetual inventory records are periodically compared with
physical counts.
Answer C is incorrect because the auditor is required to ap-

ply analytical procedures as risk assessment procedures t~
obtain an understanding of the entity and its environm~n
1
and in the overall review at the end of the audit. Analyuca
procedures may also be applied as substantive procedures.
Answer D is incorrect because the auditor is not require~:~

document the basis if control risk is assessed at the m
mum level for some assertions.
leling the Audit and Post-audit Responsibilities 667
R 9 comP
~p!E
tten management representation letter is most likely to
J6· />. wri auditor's best source of corroborative information of a
b~ a~s intention to
c1 1 e~ ttle an outstanding lawsuit for an amount less than the
f>.. a~cn..1ed loss c~ntingen~.
Discontinue a line of business.
8· Terminate an employee pension plan.
c. [Vlake a public offering of its ordinary share capital.
o.
Written mana~ement representati?ns do not substitute for
ther audit evidence that the auditor could reasonably ex-
oect to be available. However, in some circumstances, audit
p idence other than that obtained from inquiries may not be
e;asonably expected to be available. For example, the audi-
~or's procedures may provide little or no evidence to cor-
roborate management's intention to discontinue a line of
business. Accordingly, written representations will be nec-
essary to confirm management's intent.
Answers A, C, and D are incorrect because other audit evi-

dence is expected to be available to corroborate manage-
ment's intent to settle an outstanding lawsuit, terminate an
employee pension plan, or make a public offerir..g of an enti-
ty's ordinary share capital.
37. When considering the use of management's written repre-

sentations as audit evidence about the completeness asser-
tion, an auditor should understand that such representations
A. Constitute sufficient appropriate audit evidence to sup-
port the assertion when considered in combination with
a sufficiently low assessed level of control risk.
B. Are not part of the audit evidence considered to support
the assertion.
C. Replace a low assessed level of control risk as audit evi-
dence to support the assertion.
r -
... - r..... ~ ~~,.-. .. ·- .. . . .. : -
I l
D. Complement, but do not replace, substantive tests de-

signed to support the assertion.
Management representations cannot be a substitute for oth-

er audit evidence that the auditor could reasonably expect
to be available. Thus, they complement, but do not replace,
other audit evidence to corroborate management's asser-
tions.
Answer A is incorrect because, regardless of the assessed

level of control risk, the auditor should perform substantive
tests to verify management's assertions and detect mis-
statements.
Answer B is incorrect because management's written repre-

sentations are consid~red audit evidence.
Answer C is incorrect because management's written repre-

sentations complement, but do not replace, substantive
tests of account balances, transaction classes, and disclosure
components of the financial statements. Control risk is as-
.n
sessed only to determine the acceptable level of detecti.0
risk, which, in turn, is considered in designing substantive
tests.
38. The written representations shall be in the form of a repre·

sentation letter addressed to the
A. Entity's management
B. Auditor
C. Entity's chief executive officer
D. Entity's chief financial officer
. t~~
39. A written repres.entation from a client's managemen the
among ·other matters, acknowledges responsibility for
C~p1EER
. resentation of financial statements, should normally be
fair p b the
signed y . I ffi d .
Chief financ1a o icer an the chair of the board of direc-
A· tors. .
Chief executive officer and the chief financial officer.
6· Chief executive officer, the chair of the board of direc-
c. tors, and the client's lawyer.
chair of the audit committee of the board of directors.
o.
A management representation letter would ordinarily be
j .
5
·gned by the members of management who have primary
\ \
~sponsibility for the entity and its financial aspects based
r n their best knowledge and belief. These members are or-
~inarily the senior executive officer and the senior financial
officer.
However, the auditor is not precluded from obtaining writ-

ten representation from other members of management.
For example, the auditor may obtain a written representa-
tion about the completeness of the minutes of meetings of
the board of directors, stockholders, and other committees
from the individual who has custody of such minutes.
40. The following statements are ordinarily included in a man-

agement representation letter, except
A. The completeness and availability of minutes of share-
holders' and directors' meetings.
B. Sufficient appropriate audit evidence has been made
available to permit the expression of an unmodified opin-
ion.
C. There have been no irregularities involving management
or employees who have a significant role in internal con-
trol or that could have a material effect on the financial
statements.
~--......lllLl.1!&1.lii!m!!!!IJ~........~-·~E!!&!J~
. !!-4!2Ml~~JIL&EBl!l.lilmlllll. . . . . . . . . . . . . ...,__.,,,,_..~~
'1
-
, D. The financial statements are free of material misstate-

ments, including omissions.
The auditor should perform audit procedures to gather suf-

ficient appropriate audit evidence on which the opinion is to
be based.
Answers A, C, and D are incorrect because they include mat-

ters ~hat are ordinarily included in the management repre-
sentation letter.
41. What type of opinion is most appropriate when management

does not provide written representations about its responsi-
bility for the preparation of the financial statements?
A. Qualified opinion
B. Disclaimer of opinion
C. Adverse opinion
D. Unmodified opinion
42. To which of the following matters would materiality ~imi~

not apply in obtaining written management representations.
A. Reductions of obsolete inventory to net realizable value~
B. The disclosure of compensating balance arrangemen
involving related parties.
· · exce 55
C. Losses from purchase commitments at prices tn
of market value. . ctors'
D. The availability of minutes of shareholders' and dire
meetings.
Jirnited
Written representations from management may be oJ!eC·
to matters that are considered either individually or cect to
tively material to the financial statements. With res~nforfll
1
certain items, it may be necessary for the auditor.to
management of his/her understanding of materialltY-
leting the Audit and Post-audit Responsibilities 671
fr , 9 cornP
c#pff:~
·aJity limits do not apply to management's representa-
1 1ty o f minutes
•1atert ncerning t h e ava1·1 a b·1·
1n
. of shareholders'
tiO; ~~rectors' meetings since it is independent of amounts
<)
an financial statements.
in the
A 8, and C are incorrect because reductions of ob-
j\nSWers ' .
te inventory to net realizable value, disclosure of com-
1
s~:sating balance arrangements involving relat!;!d parties,
P d losses from purchase commitments all relate to
an unts in the financial statements to which materiality
3mo
limits apply.
Which of the following statements concerning management

43· epresentations is incorrect?
~. Representations by management can be a substitute for
other audit evidence that the auditor could reasonably
expect to be available.
B. If the auditor is unable to obtain sufficient appropriate
audit evidence regarding a m~tter, which has, or may
have, a material effect on the financial statements and
such audit evidence is expected to be available, .this will
constitute a limitation in the scope of the audit, even if a
representation from management has been received on
the matter.
c. If a representation by management is contradicted by
other audit evidence, the auditor should investigate the
circumstances and, when necessary, reconsider the reli-
ability of other representations by management.
D. The auditor's working papers would ordinarily include a
summary of oral discussions with management or written
representations from management.
According to the standard, representations by management

cannot be a substitute for other audit evidence that the au-
ditor could reasonably expect to be available. For example,
a representation by management as to the cost of an asset is

not a substitute for the audit evidence of such cost that an
auditor would ordinarily expect to obtain.
44. If management does not provide one or more of the re-

quested written representations, the auditor shall
I. Discuss the matter with management.
IL Reevaluate the integrity of management and evaluate
the effect that this may have on the reliability of repre-
sentations (oral or written) and audit evidence in gen-
eral. ·
III. Take appropriate actions, including determining the
possible effect on the opinion in the auditor's report.
A. I only
B. I and II only
C. I and III only
D. I, II, and III
45. Which of the following statements concerning written man-

agement representations is incorrect? .
A. The written representations shall be in the form of a rep
resentation letter addressed to the entity's chief execu·
tive officer and chief financial officer. . rrorn
B. The auditor shall request written rep~e~~~tationsthe fi·
management with appropriate respons1b1ht1es for con·
nancial statements and knowledge of the matters
cerned. st rnan·
C. The auditor may consider it necessary to . reque t it has
agement to provide a written represe~tat1?n ~~a internal
communicated to the auditor all defic1enc1es
control of which management is aware. . t rnanage·
D. Audit evidence obtained during the audit tha ration of
ment has fulfilled its responsibility for the. pr~~: applica·
the financial statements in accordance with
ct!Ap1t:R
ble financial reporti~g framework is not sufficient without

obtaining confirma~ton from management that it believes
that it has fulfilled its responsibility.
URES REGARDING LITIGATION AND CLAIMS

p~ocED
The primary source of information to be reported about liti-
46. tion claims, and assessments is the
ga I d'
A. Independent au 1tor
Client's management
6
c: court records
o. Client's lawyer
Management should adopt policies and procedures to iden-

tify, evaluate, and account for litigation, claims, and assess-
ments as a basis for the preparation of financial statements
in accordance with the applicable financial reporting
framework.
Answer A is incorrect because the auditor's responsibility is

to perform au~it procedures in order to become aware of
any litigation and claims involving the entity that may result
in a material misstatement of the financial statements (PSA
501, Audit Evidence - Additional Considerations for Specific
Items).
Answer C is incorrect because there is no requirement to

examine court records.
Answer D is incorrect because the client's lawyer corrobo-

rates the information furnished by the client's management.
47. Which of the following procedures is least likely to be per-

formed by the auditor to identify litigation and claims involv-
ing the entity which may result in a material misstatement of

the financial statements?
A. Confirm directly with the client's lawyer that all claims
have been recorded in the financial statements.
B. Make appropriate inquiries of management including ob-
taining representations.
C. Examine legal expense accounts.
D. Use any information regarding the entity's business in-
cluding information obtained from discussions with any
in-house legal department.
A loss contingency is recognized in the financial statements

only if it is probable and the amount can be reasonably es·
timated. Therefore, not all contingent claims are recognized
in the financial statements.
Answers 8, C, and D are incorrect because they describe

procedures that the auditor would have to carry out to iden·
tify litigation and claims involving the entity.
48. The primary reason an auditor requests that letters of. in·
quiry be sent to a client's attorneys is to provide the auditor
with . d as·
A. A description and evaluation of litigation, claims, an
sessments that existed at the balance sheet d~te. eri·
B. The attorneys' opinions of the client's historical exp
ences in recent similar litigation. nage·
C. Corroboration of the information furnished by ma
ment about litigation, claims, and assessments. ding or
D. The probable outcome of asserted claims and pen
threatened litigation.
. for se·
PSA 501 (Audit Evidence-Specific Considerations risk of
lected Items) states that when the auditor assess~s .~ 5 thllt
material misstatement regarding litigation or c at
cwV',-eR
been identified or when the auditor believes they may
ha~~ the auditor should seek direct communication with
exis:ntity's legal counsel. Such communicatien will assist in
the ining sufficient appropriate audit evidence as to wheth-
obtaotentially matena · 1 l'1t1gat1on
· · an d cIaims are known an d
er p agement's estimates of the financial implications, in-
eluding costs, are re 1·1abl e.
111an
Answers A and D are incorrect because, as stated in the

tandard, the letter would ordinarily specify the following
5
:ill
hen it is considered unlikely that the entity's legal counsel
respond to a general inquiry:
• A list of litigation and claims.
• Management's assessment of the outcome of the liti-
gation or claim and its esHmate of the financial im-
plications, including costs involved.
• A request that the entity's legal counsel confirm the
reasonableness of management's assessment and
provide the auditor with further information if the
list is considered by the entity's legal counsel to be
incomplete or incorrect.
Answer B is incorrect because the auditor is primarqy con-

cerned with current litigation involving the entity, not the
client's historical experiences in recent similar litigation.
49. The letter of audit inquiry should be

A. Prepared and sent by the auditor.
B. Prepared by management and sent by the auditor.
C. Prepared and sent by management.
D. Prepared by the auditor and sent by management.
-·- ·· -;:::-:--.
- :- -- ·~· .. - - -:---- ... ~- - ·'"--" . .~ . ... .i
The letter of audit inquiry, which should be prepared by

management and sent by the auditor, requests the entity's
legal counsel to communicate directly with the auditor.
50. An auditor should obtain evidence relevant to all of the fol-

lowing factors concerning third-party litigation against a cli-
ent except the
A. Jurisdiction in which the matter will be resolved.
B. Existence of a situation indicating an uncertainty as to
the possible loss.
C. Probability of an unfavorable outcome.
D. Period in which the underlying cause for legal action oc-
curred.
When performing procedures after year-end concerning lit-

igation and claim's, the auditor is primarily concerned wit~
the impact of the matter on the fair presentation of the cli-
ent's financial statements.
-·------~--~
Accordingly, the auditor should obtain sufficient appropri-
ate audit evidence about the existence, amount, probabili~
of an unfavorable outcome, and timing of the cause of the lit-
igation or claims. ·
The auditor is least interested in determining the jurisdiC·

tion in which the litigation will be resolved.
· ty as
Answer B, C, and D are incorrect because the uncertain t·
to the possible loss, the probability of an unfavorable oual
come, and the period in which the underlying cause for ~gbY
action occurred are matters that should be considere fi·
the auditor to determine the impact of litigation on the
nancial statements.
c~prER
fhe refusal .0 f a client's. lawyer to provide a representation

51· n the legality of a particular act committed by the client is
~rdinarily ·
A. proper ~rounds to withdra~ from the engagement.
6 Insufficient reason to modify the auditor's report because
· of the lawyer's obligation of confidentiality.
c. considered to be a scope limitation.
o. sufficient reason to issue a "subject to" opinion.
pSA 501 states that where the entity's legal counsel refuses
to respond in an appropriate manner and the auditor is un-
able to obtain sufficient appropriate audit evidence by ap-
plying alternative au?it procedures, the auditor would con-
sider whether there is a scope limitation which may lead to
a qualified opinion or a disclaimer of opinion.
Answer A is incorrect because the lawyer's failure to cor-

roborate information furnished by management could lead
to a qualified opinion or a disclaimer of opinion but would
not be considered proper grounds for withdrawal from the
engagement.
Answer Bis incorrect because the auditor could be preclud-

ed from expressing an unmodified opinion when there is a
material scope limitation.
Answer D is incorrect because "subject to" is not allowed t0

be used as a qualifying phrase in an auditor's report.
52. Management's refusal to give the auditor permission to

communicate with the entity's legal counsel is most likely to
lead to
A. An adverse opinion.
B. A qualified opinion or an adverse opinioo.
-
C. An unmodified opinion. .
D. A qualified opinion or a disclaimer of opinion.
If management refuses to give the auditor permission to

communicate with the entity's legal counsel, this would be a
scope limitation and should ordinarily lead to a qualified
opinion or a disclaimer of opinion.
53. In which of the following circumstances would an auditor

most likely meet with the client's legal counsel to discuss the
likely outcome of the litigation and claims?
I. The auditor determines that the matter is a significant
risk.
II. There is a disagreement between management and the
entity's legal counsel.
III. The subject matter of the litigation is complex.
A. I and II only C. I and III only
B. .II and III only D. I, II, and III
PSA 501 states that, in certain circumstances, for example,

where the auditor determines that the matter is a significant
risk, the matter is complex or there is disagreement be·
tween management and the entity's legal counsel, it may be
necessary for the auditor to meet with the entity's legal
co~nsel to discuss the likely outcome of litigation an~
claim~. ~uch meetings would take place with management 5
permissmn and, preferably, with a representative of rnan·
agement in attendance.
54 Wh' h · t'S
· ic of the following statements extracted from a clien
lawye~s letter concerning litigation claims and assessments
most likely Id ' ' . · n1
A "I . wou cause the auditor to request clanficatio ·he
· d believe that the action can be settled for less than t
amages claimed."
\

~prfR
"l believe that the company will be able to defend this

13. action successfully." . .
"l believe that the plaintiff's case against the company is
c. without merit." .
"l believe that the possible liability to the company is
0· nominal in amount."
The Jetter of ~ud~t inquiry requests the entity's lawyer to

evaluate the hkehhood of an unfavorable outcome and, if
ossible, to make an estimate of the amount or range of po-
f ntial Joss. A statement that the action can be settled for
J:ss than the damages claimed is unclear as to the amount
or range of potential loss.
Answers Band Care incorrect because the responses clearly

state that the entity should not expect any liability to arise
from the lawsuit. Answer D is incorrect because the re-
sponse is clear as to the amount or range of possible loss.
55. The auditor should consider the status of legal matters up to

the
A. Balance sheet date
B. Date of the auditor's report
c. Date of approval of the financial statements
D. Date of issuance of the financial statements
. L&liE.JWJ,.£ JJ&E -
-
TRUE OR FALSE
1. If a potential loss on a contingent liability is remote, the lia-

bility usually is disclosed in the auditor's report but not dis-
closed on the financial statements.
2. When obtaining evidence regarding litigation against a client1

the CPA would be least interested in determining the period
in which th~ underlying cause of the litigation occurred.
3. The auditor has no responsibility for events occurring in the

subsequent period unless these events affect transactions
recorded on or before the balance sheet date.
4. The standard letter of inquiry to the client's legal couns.el

should be prepared on auditor's stationery and signed by an
audit partner.
5. The auditor's primary means of obtaining corroboration °~

0
management's information concerning litigation is a letter
audit inquiry to the client's lawyer.
6. When a client will not permit inquiry of outside legal cou~~~~

the audit report will ordinarily contain an unmodified opini
with an emphasis of matter paragraph.
7. An auditor has the responsibility to actively search/~~:~~~

0
sequent events that occur subsequent to the date
ditor's report.
·des writ·
8. A letter of representations from managemen~ profvi vidence
ten documentation, which is a higher quality 0 e
than management's oral responses to inquiries.
.ApfER
ctir
If a lawy~r. re~uses to _furnish corroborating information re-

9. arding l1t1gation, claims, and assessments the auditor
~hould consider the refusal to be a scope limit~tion.
After an auditor has issued an audit report, there is no obli-
1o. gation to make any further audit tests or inquiries with re-
spect to the audi~ed fina~cial statements covered by that re-
port unl~ss new information comes to the auditor's attention
concerning an event that occurred prior to the date of the
auditor's report that may have affected the auditor's report.
11 · The date of the management representation letter should

coincide with t he d ate of the auditor's report.
12. The management letter is used to allow management to cor-

roborate oral representations to the auditor.
13, Auditors should perform audit procedures relating to subse-

quent events through the last day of field work.
14. The review of audit working papers.by the audit partner is

normally completed immediat~ly as each working paper is
completed.
15. Subsequent events for which disclosure, but no adjustment,

is required provide information about significant
events/conditions which did not exist at the balance sheet
date.
16. Subsequent events which require adjustment to the financial

statements provide additional information about significant
conditions/events which existed at the balance sheet date.
17. The date of the management representation letter received

from the client should coincide with the balance sheet date .
•
18. Generally, loss contingencies that are judged to be remote

should be disclosed in the notes to the financial statements.
19. To obtain eviderice about an entity's subsequent events, an

auditor would reconcile bank activity for the month after the
balance sheet date with cash activity reflected in the ac-
counting records.
20. The auditor is required to evaluate whether there is a sub-

stantial doubt about a client's ability to continue as a going
concern for at least one year beyond the date of the audi-
tor's report.
21. The auditor is required to confirm directly with the client's

lawyer that all claims have been recorded in the financial
statements.
22. A lawyer is responding to an independent auditor as a result

of the audit client's letter of inquiry. The lawyer may appro-
priately limit the response to matters to which the attorney
has given substantive attention in the form of legal consulta-
tion or representation.
23. Subsequent events for which the auditor has a responsibility

to actively search are defined as events which occur subse-
quent to the balance sheet date.
24. · The letter of representation is signed by high-level corpora.~

officials, usually the chief executive officer and chief financr
officer.
ntation
25. Refusal by a client to prepare and sign the represe ·nion
letter would require the auditor to issue a qualified 0 P'
or a disclaimer.
#reR
ANSWERS
K~ v
15. A 29. A 43. A

1. B
z. c 16. A 30. c 44. D
3, B 17. B 31. A 45 .. A
4. c 18. B 32. c 46. B
s. A 19. c 33. D 47. A
6. D 20. D 34. A 48. c
7. D 21. c 35. B 49. B
8. B 22. B 36. B 50. A
9. c 23. B 37. D 51. c

10. A 24. c 38. B 52. D
11. B 25. A 39. B 53. D
12. c 26. A 40. B 54. A
13. c 27. B 41. B 55. B
14. c 28. D 42. D

-
TRUE OR FALSE
1. False 6. False 11. True 16. True 21. False
2. False 7. False 12. False 17. False 22. True
3. False 8. False 13. True 18. False 23. False
4. False 9. True 14. False 19. False 24. True
5. True 10. True 15. True 20. False 25. True

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1. Analytical procedures used in the overall review stage of the

the audit that assist the auditor when forming an overall

Analytical procedures used in the final review stage of t;he

Analytical procedures applied as an overall review in the

Answer A is incorrect b~cause analytical procedures are not

Answer C is incorrect because there may be nothing unusual

Answer D is incorrect because analytical procedures are not

2. Analytical procedures performed in the overall review stage

relationships. The results of these procedures most likely

The auditor should perform analytical procedures in the fi-

When analytical procedures disclosed significant fluctua-

The auditor's investigation of unusual fluctuations begins

Answer A is incorrect because the auditor should first ob·

Answer B is incorr~ct because it is the auditor's investiga-

Answer D is incorr:ct because the auditor performs tests of

RELATED PARTY TRANSACTIONS

3. The responsibility for the identification and disclosure of re-

4. The auditor should review information provided by those

636 CPA EXAMINATION REVIEWER: AUDITING THEORY

The auditor should review information provided by those

5. Which of the following events most likely indicates the exist-

The following suggest related party transactions:

• Transactions which have abnormal terms of trade,

Answer D is incorrect because large sums of money are

Which of the following would not necessarily be a related

a) Directly, or indirectly through one or more intermediar-

638 CPA EXAMINATION REVIEWER: AUDITING THEORY

e) The party is a close member of the family of any individ-

Two corporations having a similar name are not necessarily

Answers A, B, and Care incorrect because these transactions

7. Which of the following procedures should be performed by

PSA 550 (Related Parties) requires the auditor to revieW ind

management identifying. the. names of known related par-

8. Which of the following statements concerning related party

640 CPA EXAMINATION RE-VIEWER: AUDITING THEORY

C. An auditor should determine whether a particular trans-

PSA 550 states that in examining the identified related party

Answer A is incorrect because the existence of related par-

Answer C is incorrect because, unless the transaction is rou-

Answer D is incorrect because related party transactions

o. rntercompan~ tra nstatctions ~ay have been consummated

While the existence of. related parties and transactions with

Answer A is incorrect because the auditor is not required to

Answer Bis incorrect because determining whether particu-

Answer D is incorrect because related party transactions

10,. After determining that a related party transaction has, in

After identifying related party transactions, the auditor

Answer B is incorrect because the auditor's primary concern

Answer C is incorrect because no modification of the report

Answ~r D is incorrect because ·management is responsible

11. Which of the following audit procedures is most likely to as·

The following _a re examples of audit procedures which may

Reviewing accounting records for large or unusual transac-

Revi~wing confirmations of loans receivable and payable

Answer A is incorrect because the purpose of inspecting

Answer C is incorrect because the auditor should not retest

Answer D is incorrect because confirmations of accounts re-

12. For a reporting entity that has participated in related party

PAS 24 (Related Party Disclosures) provides that if an enti~

As a minimum, the disclosures should include:

sussEQUENT EVENTS REVIEW