ACCY6301 Final Q - Audit Sampling Questions PDF

Ch. 15, 17 Audit sampling **15-23 (OBJECTIVES 15-5, 15-7)** The following items apply to determining sample sizes using random sampling from large populations for attributes sampling. Select the most appropriate response for each question. a.If all other factors specified in a sampling plan remain...

Ch. 15, 17 Audit sampling **15-23 (OBJECTIVES 15-5, 15-7)** The following items apply to determining sample sizes using random sampling from large populations for attributes sampling. Select the most appropriate response for each question. a.If all other factors specified in a sampling plan remain constant, changing the ARO from 5 percent to 10 percent will cause the required sample size to (1)increase. (2)remain the same. (3)decrease. (4)become indeterminate. b\. Of the four factors that determine the initial sample size in attributes sampling (population size, tolerable exception rate, acceptable risk of overreliance, and expected population exception rate), which factor has the least effect on sample size? \(1) Population size (2)Expected population exception rate (3)Tolerable exception rate (4)Acceptable risk of overreliance In determining the sample size for a test of controls, an auditor should consider the likely rate of exception, the acceptable risk of overreliance, and the 1. risk of incorrect acceptance. 2. tolerable exception rate. 3. nature and cause of exceptions. 4. population size. **15-24c** In addition to evaluating the frequency of deviations in tests of controls, an auditor should also consider certain qualitative aspects of the deviations. The auditor most likely would give additional consideration to the implications of a deviation if it was **15-25** The following questions concern audit sampling. a\. An advantage of statistical sampling over nonstatistical sampling is that statistical sampling helps an auditor \(1) minimize the failure to detect errors and fraud. \(2) eliminate the risk of nonsampling errors. \(3) design more effective audit procedures. \(4) measure the sufficiency of the audit evidence by quantifying sampling risk. b\. Which of the following best illustrates the concept of sampling risk? \(1) The documents related to the chosen sample may not be available to the auditor for inspection. \(2) An auditor may fail to recognize errors in the documents from the sample. \(3) A randomly chosen sample may not be representative of the population as a whole for the characteristic of interest. \(4) An auditor may select audit procedures that are not appropriate to achieve the specific objective. c\. For which of the following tests would an auditor most likely use attributes sampling? **15-26 a&c** The following questions concern audit sampling. a\. As compared to a nonstatistical sampling plan, a statistical sampling plan c\. In assessing sampling risk, the risk of incorrect rejection and the risk of assessing control risk too high relate to the \(1) efficiency of the audit. \(2) effectiveness of the audit. \(3) selection of the items in the sample. \(4) audit quality controls. b\. For each of the columns numbered 1 through 7, determine the initial sample size needed to satisfy the auditor's requirements using attributes sampling from the appropriate part of [Table 15-8](https://plus.pearson.com/products/674a472e-3640-4d5f-a10a-ed69f4e773e0/pages/5b209a90-e85d-11ee-ba98-97e9086b3499.xhtml#abca94dccd4571499a2c6ad28234ff8b). c. Using your understanding of the relationship between the following factors and sample size, state the effect on the initial sample size (increase or decrease) of changing each of the following factors while the other three are held constant: d\. Explain why there is such a large difference in the sample sizes for columns 3 and 6. **Ch 17** **17-21** The following questions relate to determining sample size in tests of details of balances. a\. Murray decides to use stratified sampling. The reason for using stratified sampling rather than unrestricted random sampling is to b\. How would increase in tolerable misstatement and assessed level of control risk affect the sample size in substantive tests of details? A white rectangular object with black text Description automatically generated c\. Which of the following sample planning factors will influence the sample size for a test of details of balances for a specific account?  **17-22 a** following apply to evaluating results of audit sampling for tests of details of balances. a\. While performing a substantive test of details during an audit, the auditor determined that the sample results supported the conclusion that the recorded account balance was materially misstated. It was, in fact, not materially misstated. This situation illustrates the risk of **17-23a** The following relate to the use of statistical sampling for tests of details of balances. a\. When the auditor uses monetary unit statistical sampling to examine the total dollar value of invoices, each invoice **17-24 a,b** The following questions relate to nonstatistical and monetary unit sampling. a\. A number of factors influence the sample size for a substantive test of details of an account balance. All other factors being equal, which of the following would lead to a larger sample size? b\. The risk of incorrect acceptance relates to Ch. 16 Audit of accounts receivable **16-20** The following questions concern analytical procedures in the sales and collection cycle. a\. As a result of analytical procedures, the auditor determines that the gross profit percentage has declined from 30 percent in the preceding year to 20 percent in the current year. The auditor should b\. An auditor's preliminary analysis of accounts receivable turnover revealed the following rates over these accounting periods: A white square with black numbers Description automatically generated Which of the following is the most likely cause of the decrease in accounts receivable turnover? c\. After a CPA has determined that accounts receivable have increased as a result of slow collections in a "tight money" environment, the CPA will be likely to **16-21** The following questions deal with confirmation of accounts receivable. a\. The return of a positive confirmation of accounts receivable without an exception attests to the b\. Which of the following procedures will an auditor most likely perform for year-end accounts receivable confirmations when the auditor did not receive replies to second requests? c\. The negative form of accounts receivable confirmation request is useful *except* when \(4) individual account balances are relatively large. **16-22 b&c** The following questions concern audit objectives and management assertions for accounts receivable. b\. Which of the following audit procedures will best uncover an understatement of sales and accounts receivable? c\. The confirmation of customers' accounts receivable rarely provides reliable evidence about the completeness assertion because **16-23** The following questions concern auditor responsibilities related to the audit of accounts receivable. a\. The auditor sends out positive accounts receivable confirmations for a client. Assuming a second confirmation is sent out to a major customer who still fails to respond, which action should the auditor take? b\. Which of the following is least likely to be a reasonable explanation for an increase in accounts receivable turnover? c\. An auditor who is auditing accounts receivable would least likely perform which of the following tests? **16-29 b-c** Makoto Auto Parts sells new parts for foreign automobiles to auto dealers. Company policy requires that a prenumbered electronic shipping document be issued for each sale. At the time of pickup or shipment, the shipping clerk scans a bar code on the shipping document, which electronically records the date. The last shipment made in the fiscal year ended August 31, 2023, was recorded on document 2167. Shipments are billed in the order that the billing clerk receives the shipping documents. For late August and early September, shipping documents are billed on sales invoices as follows: A white rectangular object with black numbers Description automatically generated The August and September sales journals have the following information included: A screenshot of a report Description automatically generated b\. Which sales invoices, if any, are recorded in the wrong accounting period? Prepare an adjusting entry to correct the financial statement for the year ended August 31, 2023. Assume that the company uses a periodic inventory system (inventory and cost of sales do not need to be adjusted). c\. Describe, in general terms, the audit procedures you would follow in making sure that cutoff for sales is accurate at the balance sheet date. **16-31** Chen, CPA, is auditing the financial statements of a manufacturing company with a significant amount of trade accounts receivable. Chen is satisfied that the accounts are correctly summarized and classified and that allocations, reclassifications, and valuations are made in accordance with GAAP. Chen is planning to use accounts receivable confirmation requests to obtain sufficient appropriate evidence as to trade accounts receivable. a\. Identify and describe the two primary forms of accounts receivable confirmation requests and indicate what factors Chen will consider in determining when to use each. b\. Describe how Chen may use a confirmation service provider to facilitate the process. c\. Assume that Chen has received a satisfactory response to the confirmation requests. Describe how Chen can evaluate collectibility of the trade accounts receivable. d\. What are the implications to a CPA if, during an audit of accounts receivable, some of a client's trade customers do not respond to a request for positive confirmation of their accounts? e\. What auditing steps should a CPA perform if there is no response to a second request for a positive confirmation **16-34** You have been assigned to the first audit of the Chicago Company for the year ending March 31, 2023. Accounts receivables were confirmed on December 31, 2022, and at that date the receivables consisted of approximately 200 accounts with balances totaling \$956,750. Fifty of these accounts, with balances totaling \$650,725, were selected for confirmation. All but 10 of the confirmation requests have been returned; 24 were returned without any exceptions, 6 had minor differences that have been cleared satisfactorily, and 10 confirmations had the following information and comments: 1\. We are sorry, but we cannot answer your request for confirmation of our account as the PDQ Company uses an accounts payable voucher system and can only confirm individual invoices. 2\. The balance of \$1,050 was paid on December 28, 2022. 3\. The balance of \$7,750 was paid on January 5, 2023. 4\. The balance of \$2,975 was paid on December 13, 2022. 5\. We do not owe you anything at December 31, 2022, as the goods, represented by your invoice dated December 30, 2022, number 25050, in the amount of \$11,550, were received on January 5, 2023. 6\. An advance payment of \$2,500 made by us in November 2022 should cover the two invoices totaling \$1,350 shown on the statement attached. 7\. This confirmation was returned as undeliverable by the post office. 8\. We are contesting the propriety of this \$12,525 charge. We think the charge is excessive. 9\. We do not owe this balance as our agreement with the company allows us to return any unsold goods without penalty. Amount okay. As the goods have been shipped to us on consignment, we will remit payment upon selling the goods. 10\. Your credit memo dated December 5, 2022, in the amount of \$440 cancels the balance above. Ch. 21 Audit of inventory **21-14** deal with tests of details of balances & substantive analytical procedures for inventory. a\. An auditor selected items for test counts while observing a client's physical inventory. The auditor traced the test counts to the client's inventory listing. This procedure likely obtained evidence about which balance-related audit objective for inventory? b\. If the perpetual records show lower quantities of inventory than the physical count, an explanation of the difference might be unrecorded c\. An inventory turnover analysis is useful to the auditor because it may detect **21-15 (no required q)** The following questions deal with internal controls in the inventory and warehousing cycle and tests of details of balances for inventory. a\. Alpha Company uses its sales invoices for posting perpetual inventory records. Inadequate controls over the invoicing function allow goods to be shipped that are not invoiced. The inadequate controls could cause an \(1) understatement of revenues and receivables and an overstatement of inventory. \(2) understatement of revenues, receivables, and inventory. \(3) overstatement of revenues and receivables and an understatement of inventory. \(4) overstatement of revenues, receivables, and inventory. b\. As part of the current audit, the auditor begins performing substantive tests on a client's inventory. To test the valuation, allocation, and accuracy assertion, the auditor should perform all of the following procedures except for \(1) reviewing direct labor rates and testing the computation of the standard overhead rates used. \(2) performing inventory price tests on a sample of inventory items to ensure the inventory is properly valued. \(3) testing the mathematical computations of the inventory report and reconciling to the inventory general accounts. \(4) vouching a sample of items from the client's inventory report sheet to the corresponding prenumbered inventory tags. **21-P24** Latner Shoe Distributor Company maintains a large portion of the shoe merchandise in 10 warehouses throughout the eastern United States. This ensures swift delivery service for its chain of stores. You are assigned alone to the Boston warehouse to observe the physical inventory process. You encountered the following situations during the December 31, 2023, physical inventory: a. \(1) In one storeroom of 10,000 items, you have test-counted about 200 items of high value and a few items of low value. You found no misstatements. You also note that the employees are diligently following the inventory instructions. Do you think you have tested enough items? Explain. \(2) What would you do if you test-counted 150 items and found a substantial number of counting errors? b\. In observing an inventory of liquid shoe polish, you note that one lot is 5 years old. From inspection of some bottles in an open box, you find that the liquid has solidified in most of the bottles. What action should you take? c\. During your observation of the inventory count in the main warehouse, you found that most of the prenumbered tags that had been incorrectly filled out are being destroyed and thrown away. What is the significance of this procedure and what action should you take? d\. During the inventory count, several express trucks pulled in for loading. Although infrequent, express shipments must be attended to immediately. As a result, the employees who were counting the inventory stopped to assist in loading the express trucks. What should you do? **21-P27** In an annual audit at December 31, 2023, you find the following transactions near the closing date: 1\. Merchandise costing \$625 was received on December 28, 2023, and the invoice was not recorded. You located it in the hands of the purchasing agent; it was marked "on consignment." 2\. A packing case containing products costing \$816 was standing in the shipping room when the physical inventory was taken. It was not included in the inventory because it was marked "Hold for shipping instructions." Your investigation revealed that the customer's order was dated December 18, 2023, but that the case was shipped and the customer billed on January 10, 2024. The product was a stock item of your client. 3\. Merchandise received on January 3, 2024, costing \$720 was entered in the acquisitions journal on January 4, 2024. The invoice showed shipment was made FOB supplier's warehouse on December 31, 2023. Because it was not on hand December 31, it was not included in inventory. 4\. Merchandise costing \$1,822 was received on January 3, 2024, and the related acquisition invoice recorded January 5. The invoice showed the shipment was made on December 29, 2023, FOB destination. 5\. A special machine, fabricated to order for a customer, was finished and in the shipping room on December 31, 2023. The customer was billed on that date and the machine excluded from inventory, although it was shipped on January 4, 2024. **Required** a\. State whether the merchandise should be included in the client's inventory. b\. Give your reason for your decision on each item.[^\*^](https://plus.pearson.com/products/674a472e-3640-4d5f-a10a-ed69f4e773e0/pages/6d1c2e30-e85d-11ee-ba98-97e9086b3499.xhtml#40dd4796-53bc-4a34-8541-8fd4d31056f8) **21-P29a** You have been engaged for the audit of the Y Company for the year ended December 31, 2023. The Y Company is in the wholesale chemical business and makes all sales at 25% over cost. Following are portions of the client's sales and purchases accounts for the calendar year 2023. You observed the physical inventory of goods in the warehouse on December 31, 2023, and were satisfied that it was properly taken. When performing sales and purchases cutoff test, you found that on December 31, 2023, the last receiving report that had been used was no. 1063 and that no shipments have been made on any sales invoices with numbers larger than no. 968. You also obtained the following additional information: 1\. Included in the warehouse physical inventory at December 31, 2023, were chemicals that had been acquired and received on receiving report no. 1060 but for which an invoice was not received until the year 2024. Cost was \$2,183. 2\. In the warehouse at December 31, 2023, were goods that had been sold and paid for by the customer but that were not shipped out until the year 2024. They were all sold on sales invoice no. 965 and were not inventoried. A screenshot of a receipt Description automatically generated 3\. On the evening of December 31, 2023, there were two cars on the Y Company siding: a\. Car AR38162 was unloaded on January 2, 2024, and received on receiving report no. 1063. The freight was paid by the vendor. b\. Car BAE74123 was loaded and sealed on December 31, 2023, and was switched off the company's siding on January 2, 2024. The sales price was \$12,700 and the freight was paid by the customer. This order was sold on sales invoice no. 968. 4\. Temporarily stranded on December 31, 2023, on a railroad siding were two cars of chemicals en route to the Z Pulp and Paper Co. They were sold on sales invoice no. 966, and the terms were FOB destination. 5\. En route to the Y Company on December 31, 2023, was a truckload of material that was received on receiving report no. 1064. The material was shipped FOB destination, and freight of \$75 was paid by the Y Company. However, the freight was deducted from the purchase price of \$975. 6\. Included in the physical inventory were chemicals exposed to rain during transit and deemed unsalable. Their invoice cost was \$1,250, and freight charges of \$350 had been paid on the chemicals. Ch. 23 Audit of cash **23-15 (OBJECTIVES 23-3, 23-4, 23-5)** The following questions deal with auditing year-end cash and financial instruments. Choose the best response. a\. A CPA obtains a January 10 cutoff bank statement for a client directly from the bank. Very few of the outstanding checks listed on the client's December 31 bank reconciliation cleared during the cutoff period. A probable cause for this is that the client b\. In establishing the existence and ownership of an investment held by a corporation in the form of publicly traded stock, an auditor should inspect the securities or c\. The auditor should ordinarily send confirmation requests to all banks with which the client has conducted any business during the year, regardless of the year-end balance because **23-16** The following questions deal with discovering fraud in auditing year-end cash. a\. Which of the following cash transfers results in a misstatement of cash at December 31, 2023? b\. The auditor should control and verify all liquid assets simultaneously to prevent \(1) unrecorded disbursements. c\. Which of the following is one of the better auditing techniques to detect kiting? **23-17** The following questions concern auditing year-end cash and financial instruments. a\. Which of the following controls would most likely detect a kiting scheme? **23-21 a-c** In the audit of the Regional Transport Company, a large branch that maintains its own bank account, cash is periodically transferred to the central account in Cedar Rapids. On the branch account's records, bank transfers are recorded as a debit to the home office clearing account and a credit to the branch bank account. Similarly, the home office account is recorded as a debit to the central bank account and a credit to the branch office clearing account. Gordon Light is the head bookkeeper for both the home office and the branch bank accounts. Because he also reconciles the bank account, the senior auditor, Cindy Marintette, is concerned about the internal control deficiency. As a part of the year-end audit of bank transfers, Marintette asks you to schedule the transfers for the last few days in 2023 and the first few days of 2024. You prepare the following list: a\. In verifying each bank transfer, state the appropriate audit procedures you should perform. b\. Prepare any adjusting entries required in the home office records. c\. Prepare any adjusting entries required in the branch bank records. **23-P19** The following audit procedures are concerned with tests of details of general cash and financial instruments balances: 1\. Obtain a standard bank confirmation from each bank with which the client does business. 2\. Compare the balance on the bank reconciliation obtained from the client with the bank confirmation. 3\. Trace deposits in transit on the bank reconciliation to the cutoff bank statement and the current-year cash receipts journal. 4\. Compare the bank cancellation date with the date on the canceled check for checks dated on or shortly before the balance sheet date. 5\. List the check number, payee, and amount of all material checks not returned with the cutoff bank statement. 6\. Review minutes of the board of directors meetings, loan agreements, and bank confirmation for interest-bearing deposits, restrictions on the withdrawal of cash, and compensating balance agreements. 7\. Prepare a four-column proof of cash. 8\. Compare the price per share on an equity investment at year end according to the schedule of investment activity to the quoted market price according to an outside pricing source. 9\. Confirm the balance of financial instruments at year end with the broker-dealer service organization used by the client to manage its investment portfolio. **Required** Explain the objective of each audit procedure **23-P20 a&b** You are auditing general cash for the Pittsburgh Supply Company for the fiscal year ended July 31, 2023. The client has not prepared the July 31 bank reconciliation. After a brief discussion with the owner, you agree to prepare the reconciliation, with assistance from one of Pittsburgh Supply's clerks. You obtain the following information: A close-up of a document Description automatically generated Additional information obtained is as follows: 1\. Checks clearing that were outstanding on June 30 totaled \$2,411. 2\. Checks clearing that were recorded in the July disbursements journal totaled \$21,120. 3\. Deposits included \$600 from June and \$24,874 for July. 4\. A check for \$1,130 cleared the bank but had not been recorded in the cash disbursements journal. It was for an acquisition of inventory. Pittsburgh Supply uses the periodic-inventory method. 5\. A check for \$646 was charged to Pittsburgh Supply but had been written on a different company's bank account. 6\. The bank charged Pittsburgh Supply's account for a nonsufficient funds check totaling \$412. The credit manager concluded that the customer intentionally closed its account and the owner left the city. The check was turned over to a collection agency. 7\. A note for \$5,000, plus interest, was paid directly to the bank under an agreement signed four months ago. The note payable was recorded at \$5,000 on Pittsburgh Supply's books. **Required** a\. Prepare a bank reconciliation that shows both the unadjusted and adjusted balance per books. c\. What audit procedures would you use to verify each item in the bank reconciliation? Ch. 24 Completing the audit **24-20** The following questions deal with contingent liabilities and the review for subsequent events. a\. When a contingency is resolved subsequent to the issuance of audited financial statements, which correctly contained disclosure of the contingency in the footnotes based on information available at the date of issuance, the auditor should \(1) inform the appropriate authorities that the report cannot be relied on. b\. Which of the following would be least likely to be included in a standard inquiry to the client's attorney? \(1) A list provided by the client of pending litigation or asserted or unasserted claims with which the attorney has had some involvement \(2) A request that the attorney provide information about the status of pending litigation \(3) A request for the attorney to identify any pending litigation or threatened legal action not identified on a list provided by the client \(4) A request for the attorney to opine on the correct accounting treatment associated with an outstanding claim or pending lawsuit outcome c\. An example of an event occurring in the period between the end of the year being audited and the date of the auditor's report that normally will not require disclosure in the financial statements or auditor's report is \(1) decreased sales volume resulting from a general business recession. **24-21** The following questions concern communications between management, those charged with governance, and the auditor. a\. Which of the following is not a required item to be communicated by the auditor to the audit committee or others charged with governance? \(1) Information about the auditor's responsibility in an audit of financial statements b\. Written management representations obtained by the auditor in connection with a financial statement audit should include a \(1) summary of all corrected misstatements. \(2) statement of management's belief that any uncorrected misstatements are in fact not misstatements. c\. A management letter \(1) is the auditor's report on significant deficiencies and material weaknesses in internal control. **24-23** The following questions concern contingencies, subsequent events, and communications with those charged with governance. a\. A client acquired 25% of its outstanding capital stock after year end but prior to the date of the auditor's report. The auditor should \(1) disclose the acquisition in the opinion paragraph of the auditor's report. b\. Which of the following statements is correct about an auditor's required communication with those charged with governance? \(1) Any matters communicated with those charged with governance are also required to be communicated to the entity's management. \(2) The auditor is required to inform those charged with governance about significant misstatements discovered by the auditor and subsequently corrected by management. \(3) Disagreements with management about the application of accounting principles must be communicated in writing to those charged with governance. \(4) The auditor should not communicate frequently recurring misstatements unless they are material. c\. In addition to making management inquiries, an auditor should perform the following procedures to identify client contingencies with the exception of \(1) obtaining a client representation letter. **24-P27** The field work for the June 30, 2023, audit of Tracy Brewing Company was finished August 19, 2023, and the completed financial statements, accompanied by the signed audit reports, were filed September 6, 2023. In each of the highly material independent events (a. through h.), state the appropriate action (1 through 4) for the situation and justify your response. The alternative actions are as follows: 1\. Adjust the June 30, 2023, financial statements. 2\. Disclose the information in a footnote in the June 30, 2023, financial statements. 3\. Request the client to recall the June 30, 2023, statements for revision 4\. No action is required. The events are as follows: **24-P25** In an audit of the Marco Corporation as of December 31, 2023, the following situations exist. No entries have been made in the accounting records in relation to these items. 1\. During the year 2023, the Marco Corporation was named as a defendant in a suit for damages by the Dalton Company for breach of contract. An adverse decision to the Marco Corporation was rendered and the Dalton Company was awarded \$4,000,000 damages. At the time of the audit, the case was under appeal to a higher court. 2\. On December 23, 2023, the Marco Corporation declared a common stock dividend of 1,000 shares with a par value of \$1,000,000 of its common stock, payable February 2, 2024, to the common stockholders of record December 30, 2023. 3\. The Marco Corporation has guaranteed the payment of interest on the 10-year, first mortgage bonds of the Newart Company, an affiliate. Outstanding bonds of the Newart Company amount to \$5,500,000 with interest payable at 5% per annum, due June 1 and December 1 of each year. The bonds were issued by the Newart Company on December 1, 2021, and all interest payments have been met by that company with the exception of the payment due December 1, 2023. The Marco Corporation states that it will pay the defaulted interest to the bondholders on January 15, 2024. **Required** a\. Define contingent liability. b\. Describe the audit procedures you would use to learn about each of the situations listed. 1\) Can you provide a definition of a financial statement audit, describe the difference between F/S audits and other types of audits, and identify the common reasons why clients have F/S audits? (ch 1/2 & 8) **Definition of a Financial Statement Audit** A **financial statement audit** is an independent examination of an organization\'s financial statements and related disclosures to determine whether they are presented fairly in accordance with generally accepted accounting principles (GAAP) or another applicable financial reporting framework. The audit involves gathering and evaluating evidence regarding the financial statements to form an opinion on their accuracy and completeness. **Differences Between Financial Statement Audits and Other Types of Audits** **Financial Statement Audit:** An examination of an organization\'s financial statements to ensure they are free from material misstatement, whether due to fraud or error. **Internal Audits:** Conducted by an organization\'s internal audit team, focusing on evaluating internal controls, risk management, and operational efficiency. **Compliance Audits:** Assess whether an organization complies with specific legal or regulatory requirements, such as tax laws. **Forensic Audits:** Investigate financial crimes like fraud, embezzlement, or misreporting. **Performance Audits:** Evaluate the efficiency and effectiveness of an organization's resource usage to meet its goals. **Common Reasons Why Clients Have Financial Statement Audits** 1. **Regulatory Requirements**: Public companies and other regulated entities (such as banks or insurance companies) are often required by law to have their financial statements audited. 2. **Investor Confidence**: Investors, including shareholders and potential investors, rely on audits to ensure the financial statements reflect the true performance and financial position of the company. 3. **Loan Covenants**: Lenders may require audits as part of loan agreements to assess the borrower's financial health. 4. **Management\'s Assurance**: A financial statement audit provides management with a high level of assurance that their financial statements are accurate and comply with relevant standards. 5. **Mergers and Acquisitions**: During a merger or acquisition, the acquiring company may request an audit to verify the financial condition of the target company. 2\) Do you understand why audits are necessary, and can you describe the likely users of audits? (ch 1/2) Audits are necessary because they provide an independent, objective evaluation of financial statements, which helps stakeholders, such as investors, creditors, and regulators, make informed decisions. Audits offer credibility to financial reporting, reducing the risk of fraud or material misstatement. **Likely users of audits** include: - **Investors**: To assess the financial health and performance of a company. - **Creditors/Lenders**: To determine a company\'s ability to repay debt. - **Regulatory Bodies**: To ensure compliance with financial reporting and tax regulations. - **Management**: To gain confidence in their internal controls and financial reporting. - **Suppliers/Customers**: To assess the stability of business relationships. 3\) Can you distinguish among compilations, reviews, and audits, and what levels of assurance they provide? (ch 1/2)  4\) If presented with an audit opinion, can you identify what type it is (and briefly describe the major issues associated with it & assumed materiality level)? (ch. 3) **Unqualified Opinion** (Clean Opinion): This is the best possible outcome, indicating that the financial statements present fairly, in all material respects, the financial position and results of operations of the company. The auditor has found no material misstatements or limitations. **Qualified Opinion**: The auditor concludes that, except for a specific issue, the financial statements are fairly presented. This could arise from limitations on the audit scope or a disagreement with management over accounting treatment. **Adverse Opinion**: The financial statements do not present fairly the company\'s financial position or results of operations, often due to significant misstatements or non-compliance with accounting principles. **Disclaimer of Opinion**: The auditor cannot form an opinion due to significant limitations in the scope of the audit or uncertainty about the financial statements. This may occur when the auditor is unable to obtain sufficient appropriate audit evidence. 5)Given a situation, can you identify what type of audit opinion should be issued? (ch. 3) **1. Unqualified Opinion** **Situation**: The company has followed all relevant accounting standards, and there are no material misstatements in the financial statements. - **Example**: An auditor reviews a company\'s financial statements and confirms that they are prepared in accordance with GAAP, with no significant errors or misstatements. All necessary disclosures have been made, and internal controls appear effective. **2. Qualified Opinion** **Situation**: The financial statements are generally fair, but there is a specific area where the company did not fully comply with accounting standards, which is not pervasive enough to affect the overall financial statements. - **Example**: A company failed to properly account for a small portion of its inventory, but the error does not materially affect the overall financial position or performance. The auditor issues a qualified opinion regarding the inventory issue but states the rest of the financial statements are fairly presented. **3. Adverse Opinion** **Situation**: There are significant misstatements or violations of accounting standards that make the financial statements misleading or unreliable. - **Example**: A company consistently overstates its revenue, causing its financial statements to significantly misrepresent its financial position. The auditor finds that the misstatements are pervasive and material, leading to an adverse opinion on the financial statements. **4. Disclaimer of Opinion** **Situation**: The auditor is unable to obtain enough evidence to form an opinion on the financial statements due to scope limitations or uncertainties. - **Example**: The company's accounting records are incomplete, and the auditor cannot access necessary documentation. There may also be significant uncertainty about ongoing litigation that the auditor is unable to resolve. As a result, the auditor issues a disclaimer of opinion due to insufficient evidence to provide any assurance on the financial statements. 6)Can you describe to whom the AICPA rules of conduct apply, and the major differences between the AICPA rules vs. the SEC/PCAOB standards? (ch. 4) The **AICPA (American Institute of Certified Public Accountants) Rules of Conduct** apply to all **members** of the AICPA, regardless of whether they are working in public practice, industry, government, or academia. These rules are designed to promote ethical behavior, maintain public trust, and ensure that accountants and auditors adhere to high standards of integrity and professionalism. Key areas of focus within the AICPA Rules of Conduct include: - **Independence** - **Objectivity** - **Integrity** - **Confidentiality** - **Due care** - **Professional behavior** These rules serve as ethical guidelines for accountants and auditors performing audits and other services, ensuring they uphold the profession\'s credibility and avoid conflicts of interest. **Major Differences Between AICPA Rules and SEC/PCAOB Standards** While the AICPA rules apply to members of the profession, the **SEC (Securities and Exchange Commission)** and the **PCAOB (Public Company Accounting Oversight Board)** set higher and more specific standards for audits of publicly traded companies. 1. **AICPA Rules of Conduct**: - Apply to all AICPA members, including those in public practice, industry, and government. - Focus on broad ethical standards like independence, objectivity, and professional behavior. - Address general guidance for audit engagements, including guidance on **independence**, **due care**, and **confidentiality**. 2. **SEC/PCAOB Standards**: - Apply specifically to auditors of **public companies** and are more stringent in some areas, especially with regard to **independence** and **non-audit services**. - The SEC regulates the public markets, and the PCAOB sets auditing standards for public company auditors, overseeing audit firms to ensure they maintain high standards of audit quality. - The PCAOB enforces specific rules regarding **audit firm rotation**, restrictions on non-audit services provided to audit clients, and additional independence rules for auditors of public companies. - These standards also focus more on **audit quality control** and **disclosure of financial** 7\) Given a situation, can you identify whether an auditor has violated the AICPA rules of conduct? In particular, the rules over independence, direct/indirect financial interests, friends/family employment, and non-audit services allowed/disallowed? (Ch. 4) **Violations of AICPA Rules of Conduct: Key Areas** Here are some common situations where auditors might violate the AICPA Rules of Conduct, specifically regarding **independence**, **financial interests**, **family relationships**, and **non-audit services**: 1. **Independence**: - **Direct financial interest**: An auditor has a **direct financial interest** in an audit client (e.g., owning stock in the company being audited). This is a violation of the AICPA\'s **independence** rule. - **Indirect financial interest**: An auditor has an **indirect financial interest** in an audit client, such as holding shares in a mutual fund that owns stock in the audit client. Depending on the materiality and control of the investment, this may be a violation. - **Independence is impaired** if an auditor has close relationships or financial ties that may compromise objectivity or create a conflict of interest. 2. **Friends/Family Employment**: - If an auditor\'s **immediate family members** (spouse, children, or dependent relatives) or close friends are employed by the client in key positions (e.g., as an executive), this can impair the auditor's independence and violate AICPA rules. - **Employment of family members**: If a close family member works for the client in a role that could influence financial reporting or auditing (such as CFO or CEO), it might be seen as a conflict of interest, undermining independence. 3. **Non-Audit Services**: - **Non-audit services** such as bookkeeping, financial statement preparation, or management consulting can impair independence if they are provided to an audit client. - The AICPA and the SEC/PCAOB have stringent rules about providing non-audit services to audit clients, especially if the non-audit services involve taking on roles that would compromise the auditor\'s objectivity. - For instance, an auditor should **not** provide **management services** to an audit client or act in a position where they could make decisions on behalf of the client (e.g., making financial decisions or controlling operations). 8\) What is the definition of independence, and do you understand why it is critical that auditors be independent? (ch. 4) **Independence** in auditing refers to an auditor\'s ability to act objectively and impartially, free from any influences that could affect their judgment. It ensures the auditor provides an unbiased and fair assessment of financial statements. There are two types of independence: - **Independence in fact**: The auditor is truly unbiased and free from influences. - **Independence in appearance**: The auditor avoids situations that may appear biased to others. **Why Independence is Critical:** - **Credibility**: Ensures the audit opinion is trustworthy. - **Public Trust**: Auditors guide important financial decisions; lack of independence undermines trust. - **Prevention of Fraud**: Helps detect misstatements or fraud. - **Compliance**: Required by regulators to ensure accurate financial reporting. 9\) Do you understand what earnings management is, as well as why managers have incentives to commit it? (ch. 6) **Earnings management** refers to the use of accounting techniques by managers to influence the financial statements to achieve specific financial results or to smooth earnings over time. While earnings management is not necessarily illegal, it often involves making subjective choices in accounting policies or estimates, which can mislead stakeholders about the true financial position of the company. **Incentives for Earnings Management**: 1. **Meet Earnings Expectations**: Managers may manipulate earnings to meet analysts\' forecasts, avoid missing earnings expectations, or present a more favorable financial picture to investors. 2. **Executive Compensation**: Many executives\' bonuses are tied to the company\'s financial performance. By managing earnings, they can achieve performance targets that lead to higher compensation. 3. **Stock Price Optimization**: Companies may engage in earnings management to influence stock prices, such as inflating earnings to boost stock prices before issuing new shares or attracting investors. 4. **Debt Covenant Compliance**: Earnings management can help meet financial ratios or covenants in loan agreements (e.g., debt-to-equity ratios or interest coverage ratios), avoiding the risk of penalties or loan default. 5. **Tax Minimization**: Managers might manipulate earnings to reduce the company\'s tax liability by recognizing expenses in one period or deferring income to another. 10\) Do you know the differences between F/S fraud and asset misappropriation, as well as between earnings management and F/S fraud? What are the incentives to commit each of these? (ch. 6) A white grid with black text Description automatically generated  A screenshot of a computer screen Description automatically generated **Incentives to Commit These Acts:** - **Earnings Management**: - Meet performance targets or analyst expectations. - Smooth earnings to avoid volatility. - Enhance the appearance of financial stability. - **Financial Statement Fraud**: - Inflate financial performance to attract investors or secure financing. - Hide poor performance to avoid regulatory scrutiny. - Meet executive bonus targets tied to financial results. - **Asset Misappropriation**: - Personal financial gain (e.g., theft of cash or inventory). - Opportunity due to weak internal controls. - Need for money or other personal reasons. 12\) Do you understand the management assertions over B/S accounts (existence, completeness, V/A/A, classification, rights/obligations), and which types of accounts are prone to overstatement versus understatement? (ch. 6)  A screenshot of a computer Description automatically generated 13\) Given two forms of audit evidence, can you identify which is more reliable, and briefly explain why? (ch. 7) Audit evidence varies in reliability based on its source and nature. Generally, **evidence obtained from independent external sources** (such as confirmation from third parties or external documents) is considered more reliable than **evidence obtained internally** (e.g., client-prepared documents or verbal statements). This is because external sources are less likely to be influenced by the client\'s management. **Example**: A bank confirmation (external evidence) is more reliable than a client-provided bank reconciliation (internal evidence) because the bank confirmation comes directly from a third party without management\'s involvement. 14\) What is a related party transaction, and why are auditors (and others) concerned about them? (ch. 8) A **related party transaction** involves transactions between an organization and its executives, shareholders, family members, or other parties with significant influence over the company. Auditors are concerned about these transactions because they may not be conducted at arm\'s length, meaning the terms might not be fair or could involve conflicts of interest. Such transactions could be used to manipulate financial statements, evade taxes, or obscure the true financial position of the company. 15\) Do you understand the concept of materiality (and that it's considered both individually and in aggregate), why it is important, and the auditor's options assuming material misstatements are found? (ch. 9) **Materiality** refers to the significance of an omission or misstatement in financial statements, which could influence the decisions of users. Auditors assess materiality both individually for specific items and in aggregate (overall impact on the financial statements). - **Individually**: A single misstatement may be material if it could affect key decisions (e.g., misreporting a large revenue figure). - **In aggregate**: Multiple smaller misstatements might collectively add up to materiality even if each is individually immaterial. Materiality is important because auditors must decide whether misstatements are significant enough to require adjustment or disclosure. If **material misstatements** are found, the auditor can: 1. **Request correction** of the financial statements. 2. If not corrected, the auditor might issue a **qualified** or **adverse opinion** depending on the severity. 16\) Do you understand the effect of changes in inherent risk, control risk, and acceptable audit risk on audit evidence?