Chapter 24 Completing the Audit PDF

lOMoARcPSD|9162452 Chapter 24 - 021123 Finance (University of Dubai) Scan to open on Studocu Studocu is not sponsored or endorsed by any college or university Downloaded by Michael Joseph ([email protected]) ...

lOMoARcPSD|9162452 Chapter 24 - 021123 Finance (University of Dubai) Scan to open on Studocu Studocu is not sponsored or endorsed by any college or university Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 Auditing and Assurance Services, 17e (Arens/Elder/Beasley) Chapter 24 Completing the Audit 24.1 Learning Objective 24-1 1) Auditors often integrate procedures for presentation and disclosure objectives with A) Tests for transaction-related Tests for balance-related objectives objectives Yes Yes B) Tests for transaction-related Tests for balance-related objectives objectives No No C) Tests for transaction-related Tests for balance-related objectives objectives Yes No D) Tests for transaction-related Tests for balance-related objectives objectives No Yes Answer: A Terms: Procedures for presentation and disclosure objectives Difficulty: Easy Objective: LO 24-1 AACSB: Reflective thinking 2) The auditor's primary concern relative to presentation and disclosure-related objectives is A) accuracy. B) existence. C) completeness. D) occurrence. Answer: C Terms: Presentation and disclosure-related objectives Difficulty: Easy Objective: LO 24-1 AACSB: Reflective thinking 1 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 3) An auditor is reconciling the amounts included in the long-term debt footnotes to the information examined and supported in the audit files for long-term debt. Which audit objective is being satisfied? A) accuracy and valuation B) occurrence and rights and obligations C) completeness D) classification and understandability Answer: A Terms: Presentation and disclosure-related objectives Difficulty: Moderate Objective: LO 24-1 AACSB: Reflective thinking 4) Which of the following is an accurate statement regarding presentation and disclosure? A) Auditors generally set the risk as low that all required information may not be completely disclosed in the footnotes. B) Audit tests performed in earlier audit phases provides sufficient appropriate evidence about contingent liabilities and subsequent events. C) Auditors do not conduct tests of controls related to disclosures when the initial assessment of control risk is below maximum. D) In phase IV (completing the audit), auditors evaluate whether the overall presentation of the financial statements and related footnotes complies with accounting standards. Answer: D Terms: Presentation and disclosure-related audit objective performed in what phase of audit process Difficulty: Moderate Objective: LO 24-1 AACSB: Reflective thinking 5) When an auditor reviews the financial statements to determine if assets are properly classified between current and noncurrent, he or she is satisfying the audit objective of occurrence and rights and obligations. Answer: FALSE Terms: Presentation and disclosure-related objectives Difficulty: Moderate Objective: LO 24-1 AACSB: Reflective thinking 6) As part of phase IV of the audit, auditors evaluate evidence they obtained during the first three phases of the audit to determine whether they should perform additional procedures for presentation and disclosure-related objectives. Answer: TRUE Terms: Presentation and disclosure-related objectives Difficulty: Moderate Objective: LO 24-1 AACSB: Reflective thinking 2 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 7) Auditors approach obtaining evidence for presentation and disclosure objectives different with how they approach obtaining evidence for transaction-related and balance-related objectives. Answer: FALSE Terms: Presentation and disclosure-related objectives Difficulty: Moderate Objective: LO 24-1 AACSB: Reflective thinking 8) Often, procedures for the presentation objectives are integrated with the auditor's tests for transaction-related and balance-related audit objectives. Answer: TRUE Terms: Presentation and disclosure-related objectives Difficulty: Moderate Objective: LO 24-1 AACSB: Reflective thinking 9) An example of a presentation and disclosure-related objective is determining that current and noncurrent receivables are classified, separately, and any factoring or discounting of notes receivable is disclosed. Answer: TRUE Terms: Presentation and disclosure-related objectives Difficulty: Moderate Objective: LO 24-1 AACSB: Reflective thinking 10) Due to the unique nature of disclosures related to contingent liabilities and subsequent events, auditors often assess the risk as high that all required information may not be completely disclosed in the footnotes. Answer: TRUE Terms: Disclosures related to contingent liabilities and subsequent events Difficulty: Moderate Objective: LO 24-1 AACSB: Reflective thinking 11) Audit tests performed in earlier audit phases often provide sufficient appropriate evidence about contingent liabilities and subsequent events. Answer: FALSE Terms: Disclosures related to contingent liabilities and subsequent events Difficulty: Moderate Objective: LO 24-1 AACSB: Reflective thinking 3 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 24.2 Learning Objective 24-2 1) If a potential loss on a contingent liability is remote, the liability usually is A) disclosed in footnotes, but not accrued. B) neither accrued nor disclosed in footnotes. C) accrued and indicated in the body of the financial statements. D) disclosed in the auditor's report but not disclosed on the financial statements. Answer: B Terms: Contingent liability; remote Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 2) A commitment is best described as A) an agreement to commit the firm to a set of fixed conditions in the future. B) an agreement to commit the firm to a set of fixed conditions in the future that depends on company profitability. C) an agreement to commit the firm to a set of fixed conditions in the future that depends on current market conditions. D) a potential future obligation to an outside party for an as yet to be determined amount. Answer: A Terms: Commitments Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 3) Which of the following groups has the responsibility for identifying and deciding the appropriate accounting treatment for recording or disclosing contingent liabilities? A) auditors B) legal counsel C) management D) management and the auditors Answer: C Terms: Recording or disclosing contingent liabilities Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 4 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 4) You are auditing Rodgers and Company. You are aware of a potential loss due to noncompliance with environmental regulations. Management has assessed that there is a 40% chance that a $10M payment could result from the non-compliance. The appropriate financial statement treatment is to A) accrue a $4 million liability. B) disclose a liability and provide a range of outcomes. C) since there is less than a 50% chance of occurrence, ignore. D) since there is greater that a remote chance of occurrence, accrue the $10 million. Answer: B Terms: Potential loss for noncompliance Difficulty: Moderate Objective: LO 24-2 AACSB: Analytic thinking 5) Which of the following is a contingent liability with which an auditor is particularly concerned? A) Notes receivable discounted Product warranties Yes Yes B) Notes receivable discounted Product warranties No No C) Notes receivable discounted Product warranties Yes No D) Notes receivable discounted Product warranties No Yes Answer: A Terms: Contingent liability; auditor particularly concerned Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 5 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 6) Audit procedures related to contingent liabilities are initially focused on A) accuracy. B) completeness. C) existence. D) occurrence. Answer: D Terms: Audit procedures related to contingent liabilities Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 7) With which of the following client personnel would it generally not be appropriate to inquire about commitments or contingent liabilities? A) controller B) president C) accounts receivable clerk D) vice president of sales Answer: C Terms: Inquire for commitments or contingent liabilities Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 6 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 8) Inquiries of management regarding the possibility of unrecorded contingencies will be useful in uncovering A) Management's intentional failure to When management does not disclose existing contingencies. comprehend accounting disclosure requirements. Yes Yes B) Management's intentional failure to When management does not disclose existing contingencies. comprehend accounting disclosure requirements. No No C) Management's intentional failure to When management does not disclose existing contingencies. comprehend accounting disclosure requirements. Yes No D) Management's intentional failure to When management does not disclose existing contingencies. comprehend accounting disclosure requirements. No Yes Answer: D Terms: Inquiries of management; Unrecorded contingencies Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 9) Which of the following is not considered a commitment? A) agreements to purchase raw materials B) pension plans C) agreements to lease facilities at set prices D) Each of the above is a commitment. Answer: D Terms: Commitments Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 7 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 10) If an auditor concludes there are contingent liabilities, then he or she must evaluate the A) Materiality of the potential liability. Nature of the disclosure to be included in the financial statements. Yes Yes B) Materiality of the potential liability. Nature of the disclosure to be included in the financial statements. No No C) Materiality of the potential liability. Nature of the disclosure to be included in the financial statements. Yes No D) Materiality of the potential liability. Nature of the disclosure to be included in the financial statements. No Yes Answer: A Terms: Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 11) One of the primary approaches in dealing with uncertainties in loss contingencies uses a(n) ________ threshold. A) monetary B) materiality C) probability D) analytical Answer: C Terms: Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 8 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 12) If the auditor concludes that there are contingent liabilities, he or she must evaluate the significance of the potential liability and the nature of the disclosure needed in the financial statements. Which of the following statements is not true? A) The potential liability is sufficiently well known in some instances to be included in the financial statements as an actual liability. B) Disclosure may be unnecessary if the contingency is highly remote or immaterial. C) A CPA firm often obtains a separate evaluation of the potential liability from its own legal counsel rather than relying on management or management's attorneys. D) The client's attorneys must remain independent when evaluating the likelihood of losing the lawsuit. Answer: D Terms: Contingent liabilities; significance of potential liability; nature of disclosure Difficulty: Challenging Objective: LO 24-2 AACSB: Reflective thinking 13) When using the probability threshold for contingencies, the likelihood of the occurrence of the event is classified as A) not likely, likely, or highly likely. B) remote, reasonably possible, or probable. C) slight, moderate, great. D) remote, likely, possible. Answer: B Terms: Contingent liabilities Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 14) When dealing with contingencies, A) all contingencies must be disclosed or footnoted. B) the auditor must exercise considerable professional judgment when evaluating whether the client has applied the appropriate treatment. C) it is easy for the auditor to uncover contingencies without management's cooperation. D) the review for contingent liabilities is only performed at the beginning and the end of the audit. Answer: B Terms: Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 9 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 15) Which of the following is not a common audit procedure used to search for contingent liabilities? A) examine letters of credit B) examine payroll reports C) review internal revenue agent reports D) analyze legal expense Answer: B Terms: Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 16) Contingent liability disclosure in the footnotes of the financial statements would normally be made when A) the outcome of the accounting event is deemed probable, but a reasonable estimation as to the amount cannot be made by the client or auditor. B) a reasonable estimation of the loss can be made, but the outcome is not probable. C) the outcome of the accounting event is deemed probable, and a reasonable estimation as to the amount can be made. D) the outcome of the accounting event as well as a reasonable estimation of the loss cannot be made. Answer: A Terms: Contingent liability disclosure Difficulty: Challenging Objective: LO 24-2 AACSB: Reflective thinking 17) Three conditions are required for a contingent liability to exist. Which of the following is not one of those conditions? A) There is a potential future payment to an outside party or the impairment of an asset that resulted from an existing condition. B) The outcome must be resolved by a third-party. C) There is uncertainty about the amount of the future payment or impairment. D) The outcome will be resolved by some future event or events. Answer: B Terms: Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 10 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 18) A lawsuit has been filed against your client. If, in the opinion of legal counsel, the likelihood your client will lose the lawsuit is remote, no financial statement accrual or disclosure of the potential loss would generally be required. Answer: TRUE Terms: Lawsuit is remote; financial statement accrual or disclosure Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 19) Current professional auditing standards make it clear that management, not the auditor, is responsible for identifying and deciding the appropriate accounting treatment for contingent liabilities. Answer: TRUE Terms: Auditing standards; Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 20) Many of the audit procedures for finding contingencies are usually performed as an integral part of various segments of the audit rather than as a separate activity near the end of the audit. Answer: TRUE Terms: Existence of contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 21) The probability threshold for dealing with uncertainty in loss contingencies uses the terms likely and unlikely. Answer: FALSE Terms: Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 22) The first stop in the audit of contingencies is to determine the amount of the contingency. Answer: FALSE Terms: Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 11 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 23) A lawsuit has been filed but not yet resolved against an audit client. This lawsuit does not meet the conditions required for a contingent liability. Answer: FALSE Terms: Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 24) Financial statement disclosure is required if the likelihood of occurrence of an event is probable, reasonably possible, or remote. Answer: FALSE Terms: Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 25) Auditing standards make it clear that the auditor is responsible for identifying and deciding the appropriate accounting treatment for contingent liabilities due to the complexity of this topic. Answer: FALSE Terms: Contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 26) Companies ordinarily describe all commitments either in a separate footnote or combine them with a footnote related to contingencies. Answer: TRUE Terms: Commitments Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 27) Distinguish between contingent liabilities and commitments. Answer: Contingent liabilities are potential future obligations to an outside party for an unknown amount resulting from activities that have already taken place. Commitments are agreements that an entity will hold to a fixed set of conditions in the future regardless of what happens to profits or the economy as a whole. Terms: Contingent liabilities; commitments Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 12 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 28) Define the term contingent liability and discuss the criteria accountants and auditors use to classify these accounting events. Answer: A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. Three conditions are required for a contingent liability to exist: (1) there is a potential future payment to an outside party or the impairment of an asset that resulted from an existing condition; (2) there is uncertainty about the amount for the future payment or impairment; and (3) the outcome will be resolved by some future event or events. Accounting standards describe three levels of likelihood of occurrence and the appropriate financial statement treatment for each likelihood as follows: a. Probable—future event likely to occur and amount can be reasonably estimated then the financial statement accounts are adjusted. If amount cannot be reasonably estimated, then a footnote disclosure is necessary. b. Reasonably possible—chance of occurring is more than remote, but less than probable. Footnote disclosure is necessary. c. Remote—chance of occurrence is slight, no disclosure is necessary. Terms: Contingent liabilities Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 29) With what types of contingencies might an auditor be concerned? Answer: The auditor is generally concerned with contingencies arising from: 1. pending litigation for patent infringement, product liability or other actions 2. income tax disputes 3. product warranties 4. notes receivable discounted 5. guarantees of obligations of others 6. unused balances of outstanding letters of credit Terms: Types of contingencies Difficulty: Easy Objective: LO 24-2 AACSB: Reflective thinking 30) What are the three required conditions for a contingent liability to exist? Answer: 1. There is potential for future payment to an outside party or the impairment of an asset that resulted from an existing condition. 2. There is uncertainty about the amount of the future payment or impairment. 3. The outcome will be resolved by some future event or events. Terms: Conditions for contingent liability to exist Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 13 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 31) An environmental clean-up lawsuit is pending against your client. What information about the lawsuit would you as the auditor need in order to determine the proper accounting treatment? Answer: The first step is to determine if a contingency exists. Three conditions are required for a contingent liability to exist: (1) there is a potential future payment to an outside party or the impairment of an asset that resulted from an existing condition; (2) there is uncertainty about the amount for the future payment or impairment; and (3) the outcome will be resolved by some future event or events. Since the lawsuit meets the criteria for a contingent liability, the next step is to evaluate the significance of the potential liability and the nature of the disclosure needed in the financial statements to obtain evidence about the occurrence and right and obligations presentation and disclosure objective. Accounting standards describe three levels of likelihood of occurrence and the appropriate financial statement treatment for each likelihood as follows: a. Probable—future event likely to occur and amount can be reasonably estimated then the financial statement accounts are adjusted. If amount cannot be reasonably estimated, then a footnote disclosure is necessary. b. Reasonably possible—chance of occurring is more than remote, but less than probable. Footnote disclosure is necessary. c. Remote—chance of occurrence is slight. No disclosure is necessary. Terms: Correct accounting for lawsuit Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 32) Discuss three audit procedures commonly used to search for contingent liabilities. Answer: Inquire of management (orally and in writing) about the possibility of unrecorded contingencies. Review current and previous years' internal revenue agent reports for income tax settlements. Review the minutes of directors' and stockholders' meetings for indications of lawsuits or other contingencies. Analyze legal expense for the period under audit, and review invoices and statements from legal counsel for indications of contingent liabilities. Obtain a letter from each major attorney performing legal services for the client as to the status of pending litigation or other contingent liabilities. Review audit documentation for any information that may indicate a potential contingency. Examine letters of credit in force as of the balance sheet date and obtain a confirmation of the used and unused balances. Terms: Audit procedures for search of contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 14 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 33) Describe some audit procedures commonly used to search for contingent liabilities. Answer: Inquire of management in writing or orally about the possibility of unrecorded contingent liabilities; review current and previous years' internal revenue agent reports for income tax settlements or assessments or disagreements; review the minutes of directors' and stockholders' meetings; analyze legal expense and review legal invoices and statements; obtain a letter from each major attorney performing major legal services regarding pending litigation or other contingent liabilities; review audit documentation for any indication of potential contingencies like loan guarantees; examine letters of credit in force and obtain confirmations for used and unused letter of credit balances. Terms: Search for contingent liabilities Difficulty: Moderate Objective: LO 24-2 AACSB: Reflective thinking 24.3 Learning Objective 24-3 1) Auditors will generally send a standard inquiry to the client's attorney letter to A) only those attorneys who have devoted substantial time to client matters during the year. B) every attorney that the client has been involved with in the current or preceding year, plus any attorney the client engages on occasion. C) every attorney whose legal fees for the year exceed a materiality threshold. D) only the attorney who represents the client in proceeding where the client is defendant. Answer: B Terms: Standard inquiry to the client's attorney letter Difficulty: Easy Objective: LO 24-3 AACSB: Reflective thinking 15 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 2) What needs to be included in a standard inquiry to the client's attorney letter sent to a client's legal counsel? A) Any pending threatened litigation The amount of legal fees paid with which the attorney has had by the client to the attorney significant involvement Yes Yes B) Any pending threatened litigation The amount of legal fees paid with which the attorney has had by the client to the attorney significant involvement No No C) Any pending threatened litigation The amount of legal fees paid with which the attorney has had by the client to the attorney significant involvement Yes No D) Any pending threatened litigation The amount of legal fees paid with which the attorney has had by the client to the attorney significant involvement No Yes Answer: C Terms: Standard inquiry to the client's attorney letter Difficulty: Easy Objective: LO 24-3 AACSB: Reflective thinking 16 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 3) Auditors, as part of completing the audit, will request the client to send a standard inquiry to the client's attorney letter to those attorneys the company has been consulting with during the year under audit regarding legal matters of concern to the company. The primary reason the auditor requests this information is to A) determine the range of probable loss for asserted claims. B) obtain a professional opinion about the expected outcome of existing lawsuits and the likely amount of the liability, including court costs. C) obtain an outside opinion of the probability of losses in determining accruals for contingencies. D) obtain an outside opinion of the probability of losses in determining the proper footnote disclosure. Answer: B Terms: Completing the audit; Letter of inquiry Difficulty: Moderate Objective: LO 24-3 AACSB: Reflective thinking 4) The standard inquiry to the client's attorney should be prepared on A) plain paper (no letterhead) and be unsigned. B) lawyer's stationery and signed by the lawyer. C) auditor's stationery and signed by an audit partner. D) client's letterhead and signed by a company official. Answer: D Terms: Standard inquiry to the client's attorney letter Difficulty: Easy Objective: LO 24-3 AACSB: Reflective thinking 17 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 5) What is one of the main reasons an attorney may refuse to provide auditors with complete information about contingent liabilities? A) The attorneys refuse to The attorneys refuse to respond due to a disclose information they lack of knowledge about matters consider confidential. involving contingent liabilities. Yes Yes B) The attorneys refuse to The attorneys refuse to respond due to a disclose information they lack of knowledge about matters consider confidential. involving contingent liabilities. No No C) The attorneys refuse to The attorneys refuse to respond due to a disclose information they lack of knowledge about matters consider confidential. involving contingent liabilities. Yes No D) The attorneys refuse to The attorneys refuse to respond due to a disclose information they lack of knowledge about matters consider confidential. involving contingent liabilities. No Yes Answer: A Terms: Standard inquiry to the client's attorney letter Difficulty: Easy Objective: LO 24-3 AACSB: Reflective thinking 6) An attorney is aware of a violation of a patent agreement that could result in a significant loss to the client if it were known. This is an example of a(n) A) commitment. B) unasserted claim. C) pending litigation. D) subsequent event. Answer: B Terms: Standard inquiry to the client's attorney letter Difficulty: Moderate Objective: LO 24-3 AACSB: Analytic thinking 18 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 7) Management furnishes the independent auditor with information concerning litigation, claims, and assessments. Which of the following is the auditor's primary means of initiating action to corroborate such information? A) Request that client lawyers undertake a reconsideration of matters of litigation, claims, and assessments with which they were consulted during the period under examination. B) Request that client management send a standard inquiry to the client's attorney letter to those lawyers with whom management consulted concerning litigation, claims, and assessments. C) Request that client lawyers provide a legal opinion concerning the policies and procedures adopted by management to identify, evaluate, and account for litigation, claims, and assessments. D) Request that client management engage outside attorneys to suggest wording for the text of a footnote explaining the nature and probable outcome of existing litigation, claims, and assessments. Answer: B Terms: Corroborate information concerning litigation, claims, and assessments Difficulty: Challenging Objective: LO 24-3 AACSB: Reflective thinking 8) If an attorney refuses to provide the auditor with information about material existing lawsuits or unasserted claims, A) the attorney may face sanctions from the American Bar Association. B) the auditors must modify their audit report to reflect the lack of available evidence. C) the attorney can no longer represent the client. D) the auditor must withdraw from the engagement. Answer: B Terms: Response to client's letter of inquiry Difficulty: Moderate Objective: LO 24-3 AACSB: Reflective thinking 9) As directed by the Sarbanes-Oxley Act, A) an attorney must report material violations of federal securities law to the public company's chief legal counsel or chief executive officer. B) attorneys cannot breach confidentiality rules even if a client is committing a crime or a fraud. C) if the audit committee fails to remedy any material violations of the federal securities law, the attorney must report the violation to the SEC. D) All of the above are required by Sarbanes-Oxley. Answer: A Terms: Legal letter to client's attorneys Difficulty: Moderate Objective: LO 24-3 AACSB: Reflective thinking 19 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 10) When preparing a standard inquiry to the client's attorney letter, the client's letterhead should be used, and the letter should be signed by the client company's officials. Answer: TRUE Terms: Standard inquiry to the client's attorney letter Difficulty: Moderate Objective: LO 24-3 AACSB: Reflective thinking 11) In a standard inquiry to the client's attorney letter, the attorney is requested to communicate about contingencies up to the balance sheet date. Answer: FALSE Terms: Standard inquiry to the client's attorney letter Difficulty: Moderate Objective: LO 24-3 AACSB: Reflective thinking 12) If an attorney refuses to provide the auditor with information about material existing lawsuits or unasserted claims, current professional standards require that the auditor consider the refusal as a scope limitation. Answer: TRUE Terms: Attorney refuses to provide auditor with information about material existing lawsuits Difficulty: Easy Objective: LO 24-3 AACSB: Reflective thinking 13) The standard letter sent by the auditor to the attorney requests the attorney communicate about contingencies up to approximately the date of the auditor's report. Answer: TRUE Terms: Standard letter sent by auditor to the attorney Difficulty: Easy Objective: LO 24-3 AACSB: Reflective thinking 14) Attorneys must report material violations of federal securities laws to the company's audit committee. Answer: TRUE Terms: Material violations of federal security laws Difficulty: Easy Objective: LO 24-3 AACSB: Reflective thinking 20 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 15) The American Bar Association has refused to amend its attorney-client confidentiality rules to permit attorneys to breach confidentiality if a client is committing a crime or fraud. Answer: FALSE Terms: Material violations of federal security laws Difficulty: Easy Objective: LO 24-3 AACSB: Reflective thinking 16) Attorneys in recent years have become reluctant to provide certain information to auditors because of their own exposure to legal liability for providing incorrect or confidential information. State the two main reasons that attorneys refuse to provide the auditors with complete information. Answer: The attorneys refuse to respond due to a lack of knowledge about matters involving contingent liabilities. The attorneys refuse to disclose information that they consider confidential. Terms: Legal letter to client's attorneys Difficulty: Easy Objective: LO 24-3 AACSB: Reflective thinking 17) State three items that should be included in a standard inquiry to the client's attorney letter. Answer: A list including (1) pending threatened litigation and (2) asserted or unasserted claims or assessments with which the attorney has had significant involvement. This list is typically prepared by management, but management may request that the attorney prepare the list. A request that the attorney furnish information or comment about the progress of each item listed, the legal action the client intends to take, the likelihood of an unfavorable outcome, and an estimate of the amount or range of the potential loss. A request for the identification of any unlisted pending or threatened legal actions or a statement that the client's list is complete. A statement informing the attorney of his or her responsibility to inform management of legal matters requiring disclosure in the financial statements and to respond directly to the auditor. Terms: Inquiry of attorney letter Difficulty: Challenging Objective: LO 24-3 AACSB: Reflective thinking 21 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 24.4 Learning Objective 24-4 1) The auditor has a responsibility to review transactions and activities occurring after the balance sheet date to determine whether anything occurred that might affect the statements being audited. The procedures required to verify these transactions are commonly referred to as the review for A) contingent liabilities. B) subsequent year's transactions. C) late unusual occurrences. D) subsequent events. Answer: D Terms: Review transactions and activities occurring after balance sheet date Difficulty: Easy Objective: LO 24-4 AACSB: Reflective thinking 22 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 2) Which type of subsequent event requires consideration by management and evaluation by the auditor? A) Subsequent events that have a direct Subsequent events that do not have a effect on the financial statements and direct effect on the financial statements require adjustment but for which disclosure may be required Yes Yes B) Subsequent events that have a direct Subsequent events that do not have a effect on the financial statements and direct effect on the financial statements require adjustment but for which disclosure may be required No No C) Subsequent events that have a direct Subsequent events that do not have a effect on the financial statements and direct effect on the financial statements require adjustment but for which disclosure may be required Yes No D) Subsequent events that have a direct Subsequent events that do not have a effect on the financial statements and direct effect on the financial statements require adjustment but for which disclosure may be required No Yes Answer: A Terms: Subsequent events requiring consideration by management Difficulty: Easy Objective: LO 24-4 AACSB: Reflective thinking 23 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 3) Whenever subsequent events are used to evaluate the amounts included in the statements, care must be taken to distinguish between conditions that existed at the balance sheet date and those that come into being after the balance sheet date. The subsequent information should not be incorporated directly into the statements if the conditions causing the change in valuation A) took place before the balance sheet date. B) did not take place until after the balance sheet date. C) occurred both before and after the balance sheet date. D) are reimbursable through insurance policies. Answer: B Terms: Subsequent events; balance sheet date and after the end of the year Difficulty: Easy Objective: LO 24-4 AACSB: Reflective thinking 4) An auditor has the responsibility to actively search for subsequent events that occur subsequent to the A) balance sheet date. B) date of the auditor's report. C) balance sheet date, but prior to the audit report. D) date of the management representation letter. Answer: C Terms: Subsequent events Difficulty: Easy Objective: LO 24-4 AACSB: Reflective thinking 5) Which of the following subsequent events is most likely to result in an adjustment to a company's financial statements? A) merger or acquisition activities B) bankruptcy (due to deteriorating financial condition) of a customer with an outstanding accounts receivable balance C) issuance of common stock D) an uninsured loss of inventories due to a fire Answer: B Terms: Subsequent events; Adjustment to financial statements Difficulty: Easy Objective: LO 24-4 AACSB: Analytic thinking 24 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 6) After the balance sheet date, but prior to the issuance of the audit report, the client suffers an uninsured loss of their inventory as a result of a fire. The amount of the loss is material. The auditor should A) adjust the financial statements for the year under audit. B) add a paragraph to the audit report. C) advise the client to disclose the event in the notes to the financial statements. D) advise the client to delay issuing the financial statements until the economic loss can be determined. Answer: C Terms: Event will have a material effect on the financial statements Difficulty: Easy Objective: LO 24-4 AACSB: Analytic thinking 7) The auditor has completed her or his assessment of subsequent events. The proper accounting for subsequent events that have a direct effect on the financial statements is to A) adjust the financial statements for the year under audit. B) disclose in the notes to the financial statements the amount of the adjustment. C) duly note in the audit workpapers that next year's financial statements need to be adjusted. D) make no adjustment of the financial statements for the year under audit. Answer: A Terms: Subsequent events; direct effect on the financial statements Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 8) The audit procedures for the subsequent events review can be divided into two categories: (1) procedures integrated as a part of the verification of year-end account balances, and (2) those performed specifically for the purpose of discovering subsequent events. Which of the following procedures is in the first category? A) Inquire of client regarding contingent liabilities. B) Obtain a letter of representation written by client. C) Subsequent period sales and purchase transactions are examined to determine whether the cutoff is accurate. D) Review journals and ledgers of year 2 to determine the existence of any transactions related to year 1. Answer: C Terms: Audit procedures for subsequent events review Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 25 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 9) The audit procedures for the subsequent events review can be divided into two categories: (1) procedures normally integrated as a part of the verification of year-end account balances, and (2) those performed specifically for the purpose of discovering subsequent events. Which of the following procedures is in the second category? A) Correspond with attorneys. B) Test the collectability of accounts receivable by reviewing subsequent period cash receipts. C) Subsequent period sales and purchase transactions are examined to determine whether the cutoff is accurate. D) Compare the subsequent-period purchase price of inventory with the recorded cost as a test of lower of cost or market valuation. Answer: A Terms: Audit procedures for subsequent events review Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 10) Which of the following would be a subsequent discovery of facts which would not require a response by the auditor? A) discovery of the inclusion of material nonexistent sales B) discovery of the failure to write off material obsolete inventory C) discovery of the omission of a material footnote D) discovery of management's intent to increase selling prices in the future Answer: D Terms: Subsequent discovery of facts Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 11) In connection with the annual audit, which of the following is not a "subsequent events" procedure? A) Prepare any necessary closing journal entries. B) Examine the minutes of stockholders' and directors' meetings subsequent to the balance sheet date. C) Review journals and ledgers. D) Obtain a letter of representation. Answer: A Terms: Subsequent events procedure Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 26 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 12) An auditor performs interim work at various times throughout the year. The auditor's subsequent events work should be extended to the date of A) the auditor's report. B) a post-dated footnote. C) the next scheduled interim visit. D) the final billing for audit services rendered. Answer: A Terms: Interim work; Subsequent events Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 13) Which event that occurred after the end of the fiscal year under audit but prior to issuance of the auditor's report would not require disclosure in the financial statements? A) sale of a bond or capital stock issue B) loss of plant or inventories as a result of fire or flood C) a significant decline in the market price of the corporation's stock D) a merger or acquisition Answer: C Terms: Event that occurred after the end of the fiscal year Difficulty: Moderate Objective: LO 24-4 AACSB: Analytic thinking 14) Which of the following material events occurring subsequent to the balance sheet date would require an adjustment to the financial statements before they could be issued? A) loss of a plant as a result of a flood B) sale of long-term debt or capital stock C) settlement of litigation in excess of the recorded liability D) major purchase of a business that is expected to double the sales volume Answer: C Terms: Events occurring subsequent to the balance sheet date; Adjustment Difficulty: Moderate Objective: LO 24-4 AACSB: Analytic thinking 27 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 15) If the auditor determines that a subsequent event that affects the current period financial statements occurred after fieldwork was completed but before the audit report was issued, what date(s) may the auditor use on the report? A) The date of the The date of the The date on which the last day of original last day of subsequent event only fieldwork occurred along with the fieldwork only date of the subsequent event Yes Yes No B) The date of the The date of the The date on which the last day of original last day of subsequent event only fieldwork occurred along with the fieldwork only date of the subsequent event No Yes Yes C) The date of the The date of the The date on which the last day of original last day of subsequent event only fieldwork occurred along with the fieldwork only date of the subsequent event No Yes No D) The date of the The date of the The date on which the last day of original last day of subsequent event only fieldwork occurred along with the fieldwork only date of the subsequent event No No Yes Answer: B Terms: Subsequent event; report date Difficulty: Challenging Objective: LO 24-4 AACSB: Analytic thinking 16) An auditor's decision concerning whether or not to dual date an audit report is primarily based on the auditor's decision to A) extend appropriate audit procedures. B) assume responsibility for events after the date of the auditor's report. C) assume responsibility for event from fiscal year-end to the date of the audit report. D) roll the dice and hope for a successful outcome. Answer: A Terms: Dual date audit report Difficulty: Challenging Objective: LO 24-4 AACSB: Reflective thinking 28 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 17) The auditor's responsibility for "reviewing the subsequent events" of a public company that is about to issue new securities is normally limited to the period of time A) beginning with the balance sheet date and ending with the date of the auditor's report. B) beginning with the start of the fiscal year under audit and ending with the balance sheet date. C) beginning with the start of the fiscal year under audit and ending with the date of the auditor's report. D) beginning with the balance sheet date and ending with the date the registration statement becomes effective. Answer: D Terms: Reviewing subsequent events; public company; issue new securities Difficulty: Challenging Objective: LO 24-4 AACSB: Reflective thinking 18) Subsequent events affecting the realization of assets ordinarily will require an adjustment of the financial statements under examination because such events typically represent A) the culmination of conditions that existed at the balance sheet date. B) additional new information related to events that were in existence on the balance sheet date. C) final estimates of losses relating to casualties occurring in the subsequent events period. D) preliminary estimate of losses relating to new events that occurred subsequent to the balance sheet date. Answer: B Terms: Subsequent events; realization of assets Difficulty: Challenging Objective: LO 24-4 AACSB: Reflective thinking 19) An auditor's decision concerning whether or not to "dual date" the audit report is based upon the auditor's willingness to A) extend auditing procedures and assume responsibility for a greater period of time. B) accept responsibility for subsequent events. C) permit inclusion of a footnote captioned: event (unaudited) subsequent to the date of the auditor's report. D) assume responsibility for events subsequent to the issuance of the auditor's report. Answer: A Terms: Dual date audit report Difficulty: Challenging Objective: LO 24-4 AACSB: Reflective thinking 29 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 20) Auditors of accelerated filer public companies A) are responsible for reviewing subsequent events for a period of up to six months after the balance sheet date. B) must always dual-date their audit reports. C) must inquire about and consider any information about subsequent events that materially affects the effectiveness of internal control over financial reporting. D) must perform all of the above procedures. Answer: C Terms: Accelerated filers and subsequent events Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 21) A client has a calendar year-end. Listed below are four events that occurred after December 31. Which one of these subsequent events might result in adjustment of the December 31 financial statements? A) sale of a major subsidiary B) adoption of accelerated depreciation methods C) write-off of a substantial portion of inventory as obsolete D) collection of 90% of the accounts receivable existing at December 31 Answer: C Terms: Subsequent events Difficulty: Challenging Objective: LO 24-4 AACSB: Analytic thinking 22) The auditor's responsibility with respect to events occurring between the balance sheet date and the end of the audit examination is best expressed by which of the following statements? A) The auditor is fully responsible for events occurring in the subsequent period and should extend all detailed procedures through the last day of fieldwork. B) The auditor is responsible for determining that a proper cutoff has been made and performing a general review of events occurring in the subsequent period. C) The auditor's responsibility is to determine that a proper cutoff has been made and that transactions recorded on or before the balance sheet date actually occurred. D) 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. Answer: B Terms: Events occurring between balance sheet date and end of audit examination Difficulty: Challenging Objective: LO 24-4 AACSB: Reflective thinking 30 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 23) The issuance of bonds by the client subsequent to the balance sheet date would require a footnote disclosure in, but no adjustment to, the financial statements under audit. Answer: TRUE Terms: Issuance of bonds by client subsequent to year-end Difficulty: Easy Objective: LO 24-4 AACSB: Reflective thinking 24) Subsequent events which require adjustment to the financial statements provide additional information about significant conditions/events which did not exist at the balance sheet date. Answer: FALSE Terms: Subsequent events Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 25) When subsequent events are used to evaluate the amounts included in the year-end financial statements, auditors must distinguish between conditions that existed at the balance sheet date and those that came into being after the balance sheet date. Answer: TRUE Terms: Subsequent events Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 26) The auditor's responsibility for reviewing subsequent events is normally limited to thirty days after the balance sheet date. Answer: FALSE Terms: Subsequent events; balance sheet date and after the end of the year Difficulty: Easy Objective: LO 24-4 AACSB: Reflective thinking 27) When the auditor's name is associated with a registration statement under the Securities Act of 1933, the auditor's responsibility for reviewing subsequent events is limited to the date of auditor's report, not to the date the registration becomes effective. Answer: FALSE Terms: Auditor's name associated with registration statement under Securities Act of 1933 Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 31 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 28) If the auditor is unable to determine the effect of a subsequent event on the effectiveness of internal control at year-end, the auditor must give an adverse opinion on internal control over financial reporting. Answer: FALSE Terms: Subsequent event reflecting a material weakness in internal control that existed at year- end Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 29) An example of a nonrecognized subsequent event which may require disclosure if it is significant is the issuance of bonds or equity securities by a company. Answer: TRUE Terms: Subsequent events; balance sheet date and after the end of the year Difficulty: Easy Objective: LO 24-4 AACSB: Reflective thinking 32 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 30) The fieldwork for the December 31, 2018 audit of Schmidt Corporation ended on March 17, 2019. The financial statements and auditor's report were issued on March 29, 2019. In each of the material situations (1 through 5) below, indicate the appropriate action (a, b, c). The possible actions are as follows a. Adjust the December 31, 2018 financial statements. b. Disclose the information in a footnote in the December 31, 2018 financial statements. c. No action is required. The situations are as follows: ________ 1. On March 1, 2019, one of Schmidt Corporation's major customers declared bankruptcy. The customer's financial condition in 2018 was deteriorating and they owed Schmidt Corporation a large sum of money as of the balance sheet date. ________ 2. On February 17, 2019, Schmidt Corporation sold some machinery for its book value. ________ 3. On February 20, 2019 a flood destroyed the entire uninsured inventory in one of Schmidt's warehouses. ________ 4. On January 5, 2019, there was a significant decline in the market value of the securities held for resale from their value as of the balance sheet date. ________ 5. On March 10, 2019, the company settled a lawsuit at an amount significantly higher than the amount recorded as a liability on the books as of the balance sheet date. Answer: 1. a 2. c 3. b 4. b 5. a Terms: Actions for subsequent events Difficulty: Challenging Objective: LO 24-4 AACSB: Analytic thinking 33 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 31) State the two primary types of subsequent events that require consideration by management and evaluation by the auditor, and give two examples of each type. Answer: 1. Events that occur after the balance sheet date which provide additional information to management that helps them determine the fair presentation of account balances as of the balance sheet date. Information about these events helps auditors in verifying the balances. These events have a direct effect on the financial statements and require adjustment. Examples include declaration of bankruptcy by a customer with an outstanding accounts receivable balance due to deteriorating financial condition; settlement of litigation at an amount different from the amount recorded on the books; and the disposal of equipment not being used in operations at a price below the current book value. 2. Events that have no direct effect on the financial statements but for which disclosure is required. Subsequent events of this type are events that provide evidence about conditions which did not exist at the date of the balance sheet being reported on but arose after the balance sheet date and may be significant enough to require disclosure. Examples include a decline in the market value of securities held for temporary investment or resale; issuance of bonds or equity securities; a decline in the market value of inventory as a consequence of government action barring further sale of a product; the uninsured loss of inventories as a result of fire; and a merger or an acquisition. Terms: Types of subsequent events Difficulty: Moderate Objective: LO 24-4 AACSB: Reflective thinking 24.5 Learning Objective 24-5 1) The date of the management representation letter received from the client should A) be the date of latest subsequent event disclosed in the notes to the financial statements. B) be dated no earlier than the date of the audit report. C) have the same date as the date of the balance sheet. D) have the same date as the date of the engagement letter. Answer: B Terms: Management representation letter Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 34 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 2) Which of the following procedures and methods are important in assessing a company's ability to continue as a going concern? A) Discussions with management regarding Evaluation of management's plans to potential financial difficulties avoid bankruptcy Yes Yes B) Discussions with management regarding Evaluation of management's plans to potential financial difficulties avoid bankruptcy No No C) Discussions with management regarding Evaluation of management's plans to potential financial difficulties avoid bankruptcy Yes No D) Discussions with management regarding Evaluation of management's plans to potential financial difficulties avoid bankruptcy No Yes Answer: A Terms: Going concern Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 3) The letter of representation obtained from an audit client should be A) dated as of the end of the period under audit. B) dated as of the audit report date. C) dated as of any date decided upon by the client and auditor. D) dated as of the issuance of the financial statement. Answer: B Terms: Letter of representation Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 35 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 4) When should auditors generally assess a client's ability to continue as a going concern? A) upon completion of the audit B) during the planning stages of the audit C) throughout the entire audit process D) during testing and completion phases of the audit Answer: C Terms: Going concern Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 5) Which of the following would the auditor expect to find in the client's management representation letter? A) management's recommendations for internal control effectiveness improvements B) management's plans for improving product quality C) management's compliance with contractual arrangements that impact the financial statements D) management's goals for improving earnings per share Answer: C Terms: Management representation letter Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 6) Auditing standards require that the auditor evaluate whether there is a substantial doubt about a client's ability to continue as a going concern for at least A) one quarter beyond the balance sheet date. B) one quarter beyond the date of the auditor's report. C) one year beyond the balance sheet date. D) one year beyond the date of the auditor's report. Answer: C Terms: Auditing standards; Going concern issues Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 7) Auditing standards require auditors to evaluate whether there is substantial doubt about a client's ability to continue as a going concern. One of the most important audit procedures to perform to assess the going concern question is A) analytical procedures. B) confirmations from creditors. C) statistical sampling procedures. D) tests of internal controls. Answer: A Terms: Audit procedures to assess going concern Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 36 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 8) Which of the following statements regarding the letter of representation is not correct? A) It is prepared on the client's letterhead. B) It is addressed to the CPA firm. C) It is signed by high-level corporate officials, usually the president and chief financial officer. D) It is optional, not required, that the auditor obtain such a letter from management. Answer: D Terms: Letter of representation Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 9) Refusal by a client to prepare and sign the representation letter would require the auditor to issue a(n) A) qualified opinion or a disclaimer of opinion. B) adverse opinion or a disclaimer of opinion. C) qualified or an adverse opinion. D) unqualified opinion with an explanatory paragraph. Answer: A Terms: Refusal to prepare and sign the letter of representation Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 10) A management representation letter is A) prepared on the CPA's letterhead. B) addressed to the client. C) signed by high-level corporate officials. D) dated as of the balance sheet date. Answer: C Terms: Management representation letter Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 37 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 11) Which of the following is correct regarding supplementary information? A) The auditor must express an opinion on the supplementary information. B) When reporting on supplementary information, the auditor uses a different materiality threshold from that used in forming an opinion on the basic financial statements. C) If the auditor's report on the audited financial statements contains an adverse opinion, the auditor can still issue an unqualified opinion on the supplementary information. D) The auditor can issue a separate report on the supplementary information; it does not need to be part of the report on the financial statements. Answer: D Terms: Supplementary information accompanying basic financial statements Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 12) Which of the following is not one of the categories of items included in the letter of representation? A) subsequent events B) completeness of information C) recognition, measurement, and disclosure D) materiality Answer: D Terms: Client letter of representation Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 13) 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 entity's ability to continue as a going concern? A) review compliance with the terms of debt agreements B) confirmation of accounts receivable from principal customers C) reconciliation of interest expense with debt outstanding D) confirmation of bank balances Answer: A Terms: Audit procedures; Entity's ability to continue as a going concern Difficulty: Challenging Objective: LO 24-5 AACSB: Reflective thinking 38 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 14) Which of the following statements is correct? A) A letter of representation is documentation of management's acceptance of responsibility for the financial statements and is deemed to be reliable evidence. B) A letter of representation is not deemed to be reliable evidence because of the potential incompetence of management. C) A letter of representation is not deemed to be reliable evidence because it is a written statement from a nonindependent source. D) A letter of representation is documentation of the CPA's acceptance of responsibility for the audit of the financial statement and is deemed to be reliable. Answer: C Terms: Letter of representation Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 15) Auditing standards require the auditor to ________ other information included in annual reports pertaining directly to the financial statements. A) audit B) express an opinion on C) read D) analyze Answer: C Terms: Other information included in annual reports Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 16) An auditor must obtain written client representations that might be signed by all but which of the following? A) treasurer B) chief financial officer C) vice president of operations D) chief executive officer Answer: C Terms: Client representations signed by Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 39 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 17) Which of the following is not a reason why the auditor requests that the client provide a letter of representation? A) Professional auditing standards require the auditor to obtain a letter of representation. B) It impresses upon management its responsibility for the accuracy of the information in the financial statements. C) It provides written documentation of the oral responses already received to inquiries of management. D) It determines the type of opinion the auditor will issue on the financial statements. Answer: D Terms: Letter of representation Difficulty: Challenging Objective: LO 24-5 AACSB: Reflective thinking 18) At the completion of the audit, management is asked to make a written statement that it is not aware of any undisclosed contingent liabilities. This statement would appear in the A) management letter. B) letter of inquiry. C) letters testamentary. D) management letter of representation. Answer: D Terms: Completion of audit; written statement by management Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 19) Current professional auditing standards require the performance of analytical procedures during the planning and completion phases of the audit. Answer: TRUE Terms: Analytical procedures; Planning and completion phases of the audit Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 20) Current professional auditing standards mandate the use of analytical procedures during the testing phase of the audit. Answer: FALSE Terms: Professional auditing standards; Analytical procedures; Testing phase of audit Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 40 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 21) Auditing standards require the auditor's assessment of going concern issues. Answer: TRUE Terms: Auditing standards; Going concern issues Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 22) Results from the final analytical procedures may indicate that additional audit evidence is necessary. Answer: TRUE Terms: Analytical procedures in stages of audit Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 23) Although the letter of representation is typed on the client's letterhead and signed by the client, it is common for the auditor to prepare the letter. Answer: TRUE Terms: Letter of representation Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 24) Auditors of public companies must obtain certain representations from management regarding internal control over financial reporting. Answer: TRUE Terms: Representations from management regarding internal control Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 25) At the completion of the audit, management is typically asked to make a written statement as a part of the engagement letter that it is aware of no undisclosed contingent liabilities. Answer: FALSE Terms: Completion of audit; written statement by management; undisclosed liabilities Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 26) Auditors are required to obtain a letter of representation that describes management's planned solutions to all internal control weaknesses identified during an audit. Answer: FALSE Terms: Letter of representation Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 41 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 27) The letter of representation is prepared on the CPA firm's letterhead, addressed to the client's chief executive officer, and signed by the audit engagement partner. Answer: FALSE Terms: Letter of representation Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 28) If the client refuses to prepare and sign a letter of representation, the auditor would be required to issue either a qualified opinion or a disclaimer of opinion. Answer: TRUE Terms: Letter of representation; issue opinion Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 29) Because a management representation letter is a written statement from a nonindependent source, it cannot be regarded as reliable evidence. Answer: TRUE Terms: Client representation letter; reliable evidence Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 30) An example of the use of data analytics at the end of the audit is using software to scan unusual journal entries that may require additional consideration by the auditor of their potential impact on the year-end financial statements. Answer: TRUE Terms: Final audit evidence accumulation Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 31) Accounting standards generally require the financial statements to be prepared on the assumption an entity will continue its operations for a reasonable amount of time. Answer: TRUE Terms: Evaluating going-concern assumption Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 42 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 32) The Financial Accounting Standards Board (FASB) describes a reasonable period of time as two years after the date the financial statements are issued for management to evaluate the entity's ability to continue as a going concern. Answer: FALSE Terms: Evaluating going-concern assumption Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 33) The accounting standards state that management is responsible to evaluate the entity's ability to continue as a going concern within one year after the date the financial statements are issued. Answer: TRUE Terms: Evaluating going-concern assumption Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 34) The Securities and Exchange Commission has established regulations about the presentation of non-GAAP financial measures included in financial statements which include such measures should be relevant and reliable measures that do not mislead investors. Answer: TRUE Terms: Non-GAAP measures in financial statements Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 35) What two steps must an auditor take if they have reservations about the audit client continuing as a going concern? Answer: 1. Evaluate management's plan to avoid bankruptcy. 2. Determine the feasibility of management achieving those plans. Terms: Going concern Difficulty: Easy Objective: LO 24-5 AACSB: Reflective thinking 36) State the three purposes of the management representation letter. Answer: To impress upon management its responsibility for the assertions in the financial statements To remind management of potential misstatements or omissions in the financial statements To document the responses from management to inquiries about various aspects of the audit Terms: Management representation letter Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 43 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 37) List four specific matters that should be included in a client representation letter. Answer: Management's acknowledgment of its responsibility for preparing and fair presentation of the financial statements Management's acknowledgement of its responsibility for the design, implementation, and maintenance of internal controls relevant to the preparation and fair presentation of the financial statements Management's acknowledgement of its responsibility for information provided and the completeness of information provided to the auditor, including access to all financial records and related data; minutes of meetings of stockholders, directors, and committees of directors, communications from regulatory agencies concerning noncompliance with or deficiencies in financial reporting practices Management's acknowledgement of its responsibility to design, implement, and maintain internal controls to prevent and detect fraud; including disclosing the results of its fraud risk assessment to the auditor; including providing the auditor with information concerning fraud involving (a) management, (b) employees who have significant roles in internal control, or (c) others where the fraud could have a material effect on the financial statements Statement from management that it has disclosed all instances of identified or suspected non- compliance with laws and regulations whose effects should be considered when preparing the financial statements Statement from management stating that any unrecorded financial statement misstatements are immaterial to the financial statements (including a summary of those items included in or attached to the letter) Management's acknowledgement they have disclosed information about actual or possible litigation and unasserted claims or assessments that the entity's lawyer has advised are probable of assertion and must be disclosed in accordance with accounting standards Statement from management about its belief that significant assumptions used by management in making accounting estimates are reasonable Management's acknowledgement that they have disclosed to the auditor the identity of the entities related-party relationships and transactions of which management is aware and that management has appropriately accounted for and disclosed such relationships and transactions Management's acknowledgement they have adjusted or disclosed in the financial statements all events occurring after the date of the financial statements that impact of fair presentation of those financial statements in accordance with accounting standards Terms: Management representation letter Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 44 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 38) Besides the search for contingent liabilities and the review for subsequent events, the auditor has five important final evidence accumulation responsibilities, all of which are required by current professional auditing standards. Discuss each of these four responsibilities. Answer: Final analytical procedures performed as a final review for material misstatements or financial problems and to help the auditor take a final objective look at the financial statements. Evaluate the going-concern assumption. Obtain a management representation letter documenting management's most important oral representations during the audit. Consider supplementary information in relation to the financial statements taken as a whole. Read other information in the annual report. Terms: Final evidence accumulation responsibilities required by professional auditing standards Difficulty: Challenging Objective: LO 24-5 AACSB: Reflective thinking 39) The accounting standards require management to evaluate an entity's ability to continue as a going concern within one year after the date the financial statements are issued. Describe the two steps management is required to perform in performing this evaluation. Answer: Management must first evaluation whether there are conditions and events that raise substantial doubt about the entity's ability to continue as a going concern; if management concludes that substantial doubt is raised, management is also responsible to consider whether its plans alleviate that doubt. Terms: Evaluating going-concern assumption Difficulty: Moderate Objective: LO 24-5 AACSB: Reflective thinking 24.6 Learning Objective 24-6 1) To make a final evaluation as to whether sufficient appropriate evidence has been accumulated, the auditor will do all of the following except A) review the audit documentation for the entire audit to determine whether all material classes of transactions have been adequately tested. B) make sure that all parts of the audit program have been accurately completed and documented. C) obtain the management representation letter. D) decide whether the audit program is adequate. Answer: C Terms: Sufficient evidence to draw a conclusion Difficulty: Easy Objective: LO 24-6 AACSB: Reflective thinking 45 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 2) When reviewing the summary of misstatements found in the audit, A) an adjusting journal entry must be made by the auditor for all material misstatements. B) auditors must combine individually immaterial misstatements to evaluate whether the combined amount is material. C) the auditor is not required to consider the impact on the current financial statements of misstatements in the prior year that were not corrected. D) auditors only need to consider the misstatements that impact the income statement. Answer: B Terms: Sufficient evidence to draw a conclusion Difficulty: Easy Objective: LO 24-6 AACSB: Reflective thinking 3) Which of the following is an accurate statement regarding audit documentation review? A) The audit partner must review the work of the least experienced auditor in more detail than the work of the audit supervisor. B) The audit senior must review all audit documentation. C) For larger audits, it is common to have the financial statements and the entire set of audit files reviewed by someone who has not participated in the audit, but is a member of the audit firm doing the audit. D) Checklists can never be used to verify that all financial statement disclosures have been made. Answer: C Terms: Audit documentation Difficulty: Moderate Objective: LO 24-6 AACSB: Reflective thinking 4) There are three reasons why an experienced member of the audit firm must thoroughly review audit documentation of the completion of the audit, including A) to evaluate the performance of inexperienced personnel. B) to make sure that the audit meets the CPA firm's standard of performance. C) to counteract the bias that often enters into the auditor's judgment. D) all of the above. Answer: D Terms: Audit documentation Difficulty: Moderate Objective: LO 24-6 AACSB: Reflective thinking 5) An independent review must be performed of all audits. Answer: FALSE Terms: Independent review Difficulty: Easy Objective: LO 24-6 AACSB: Reflective thinking 46 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 6) If, during the completion phase of the audit, the auditor determines that he or she has not obtained sufficient evidence to draw a conclusion about the fairness of the client's financial statements, there are two choices: accumulate additional evidence or issue either a qualified or an adverse opinion. Answer: FALSE Terms: Sufficient evidence to draw a conclusion Difficulty: Moderate Objective: LO 24-6 AACSB: Reflective thinking 7) After performing all audit procedures in each area, the auditor must integrate the results into an overall conclusion about the financial statements. Answer: TRUE Terms: Sufficient evidence to draw a conclusion Difficulty: Moderate Objective: LO 24-6 AACSB: Reflective thinking 47 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 8) Match seven of the terms (a-p) with the description/definitions provided below (1-7). a. commitments b. completing the engagement checklist c. contingent liability d. dual-dated audit report e. financial statement disclosure checklist f. independent review g. inquiry of client's attorneys h. letter of representation i. other information in annual reports j. review for subsequent events k. subsequent events l. unadjusted misstatement worksheet m. management letter n. pending claim o. unasserted claim p. Audit documentation review ________ 1. a review of the financial statements and the entire set of audit files by an independent reviewer to whom the audit team must justify the evidence accumulated and the conclusions reached ________ 2. a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place ________ 3. a written communication from the client to the auditor formalizing statements that the client has made about matters pertinent to the audit ________ 4. a potential legal claim against a client where the condition for a claim exists but no claim has been filed ________ 5. transactions that occurred after the balance sheet date, which affect the fair presentation or disclosure of the statements being audited ________ 6. agreements that the entity will hold to a fixed set of conditions, such as the purchase or sale of merchandise at a stated price ________ 7. the use of one audit report date for normal subsequent events and a later date for one or more subsequent events Answer: 1. f, 2. c, 3. h, 4. o, 5. k, 6. a, 7. d Terms: Independent review; Contingent liability; Letter of representation; Unasserted claim; Subsequent events; Commitments; Dual-dated audit report Difficulty: Moderate Objective: LO 24-6 AACSB: Reflective thinking 48 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 9) List the three reasons why an experienced member of the audit firm must thoroughly review audit documentation at the completion of the audit. Answer: 1. To evaluate the performance of inexperienced personnel 2. To make sure that the audit meets the CPA firm's standard of performance 3. To counteract the bias that often enters into the auditor's judgment Terms: Audit documentation Difficulty: Moderate Objective: LO 24-6 AACSB: Reflective thinking 24.7 Learning Objective 24-7 1) The auditor is responsible for communicating significant internal control deficiencies to the audit committee, or those charged with governance. This communication A) may be oral or written. B) must be oral. C) must be written. D) must be oral via direct communication. Answer: C Terms: Communicate significant internal control deficiencies Difficulty: Easy Objective: LO 24-7 AACSB: Reflective thinking 2) Which of the following statements is most correct about an auditor's required communication with management and those charged with corporate governance? A) The auditor is required to inform those charged with governance about significant errors discovered and subsequently corrected by management. B) Any significant matter reported to those charged with governance must also be communicated to management. C) Communication is required before the audit report is issued. D) The auditor does not have any requirement to communicate with anyone other than the company's senior management. Answer: A Terms: Required communication with management; corporate governance Difficulty: Moderate Objective: LO 24-7 AACSB: Reflective thinking 49 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 3) While there is no professional requirement to do so on audit engagements, CPAs frequently issue a formal "management" letter to clients. The primary purpose of this letter is to provide A) evidence indicating whether the auditor is reasonably certain that internal accounting control is operating as prescribed. B) a permanent record of the internal accounting control work performed by the auditor during the course of the engagement. C) the client with the CPA's recommendations for improving any part of the client's business. D) a summary of the auditor's observations that resulted from the auditor's special study of internal control. Answer: C Terms: Management representation letter Difficulty: Moderate Objective: LO 24-7 AACSB: Reflective thinking 4) When communicating with the audit committee and management, A) only material fraud and illegal acts are required by auditing standards to be communicated. B) all internal control deficiencies are required by auditing standards to be communicated. C) the communications should be made in a timely manner to allow those charged with governance to take appropriate actions. D) all communications with the audit committee and management must be in writing. Answer: C Terms: Communicated to the audit committee or designate body Difficulty: Moderate Objective: LO 24-7 AACSB: Reflective thinking 5) Auditing standards require the auditor to communicate all management frauds and illegal acts to the audit committee A) only if the act is immaterial. B) only if the act is material. C) only if the act is highly material. D) regardless of materiality. Answer: D Terms: Auditing standards; Frauds and illegal acts; Audit committee Difficulty: Easy Objective: LO 24-7 AACSB: Reflective thinking 6) Auditors are required to communicate either orally or in writing with the audit committee about internal control weaknesses. Answer: FALSE Terms: Auditors required to communicate with audit committee; Internal control weaknesses Difficulty: Moderate Objective: LO 24-7 AACSB: Reflective thinking 50 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])  lOMoARcPSD|9162452 7) The Sarbanes-Oxley Act includes additional communication requirements for auditors of public companies. Answer: TRUE Terms: Sarbanes-Oxley and communication requirements Difficulty: Moderate Objective: LO 24-7 AACSB: Reflective thinking 8) Client representation letters are required by professional auditing standards, whereas management letters are optional. Answer: TRUE Terms: Client representation letters; Management letters; Auditing standards Difficulty: Moderate Objective: LO 24-7 AACSB: Reflective thinking 9) PCAOB auditing standards require the auditor to communicate key audit matters or critical audit matters in the standard unqualified audit report. Answer: TRUE Terms: Audit report considerations Difficulty: Moderate Objective: LO 24-7 AACSB: Reflective thinking 10) AICPA reporting standards do not require the communication of key audit matters, but do provide guidance for how to communicate these matters if the terms of the engagement require such disclosure. Answer: TRUE Terms: Audit report considerations Difficulty: Moderate Objective: LO 24-7 AACSB: Reflective thinking 11) List the four principal purposes of the required communication with the audit committee regarding certain additional information obtained during the audit. Answer: To communicate auditor responsibilities in the audit of financial statements To provide an overview of the scope and timing of the audit To provide those charged with governance with significant findings arising during the audit To obtain from those charged with governance information relevant to the audit Terms: Other communications with audit committee Difficulty: Moderate Objective: LO 24-7 AACSB: Reflective thinking 51 Copyright © 2020 Pearson Education, Inc. Downloaded by Michael Joseph ([email protected])