CHAPTER 24

Multiple-Choice Questions
1.
easy
d
Which of the following is not a condition for a contingent liability to exist?
a. There is a potential future payment to an outside party that would result from a current
condition.
b. There is uncertainty about the amount of the future payment.
c. The outcome of an uncertainty will be resoled by some future eent.
d. The amount of the future payment is reasonably estimable.
!.
easy
c
"uditors often integrate procedures for presentation and disclosure ob#ecties with$
a. tests for transaction-related ob#ecties.
b. tests for balance-related ob#ecties.
c. a and b.
d. neither " nor %.
&.
easy
b
'f a potential loss on a contingent liability is remote( the liability should be$
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.
*.
easy
c
Which of the following is an incorrect combination of the +li,elihood of occurrence- and
financial statement treatment?
a. .emote / no disclosure.
b. 0robable 1amount is estimable2 / financial statements are ad#usted.
c. .easonably possible 1amount is estimable2 / financial statements are ad#usted.
d. 0robable 1amount is not estimable2 / footnote disclosure is re3uired.
4.
easy
c
5ne of the auditor)s primary concerns relatie to presentation and disclosure-related ob#ecties
is$
a. accuracy.
b. existence.
c. completeness.
d. occurrence.
6.
easy
d
"t the completion of the audit( management is as,ed to ma,e 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 in3uiry.
c. letters testamentary.
d. letter of representation.
7.
easy
c
The responsibility for identifying and deciding the appropriate accounting treatment for
contingent liabilities rests with a company)s 88888.
a. auditors.
b. legal counsel.
c. management.
d. management and their auditors.
!*-1
9.
easy
c
:;": 4 describes 88888 leels of li,elihood of occurrence.
a. one
b. two
c. three
d. four
<.
easy
d
The auditor has a responsibility to reiew transactions and actiities occurring after the year-end
to determine whether anything occurred that might affect the statements being audited. The
procedures re3uired to erify these transactions are commonly referred to as the reiew for$
a. contingent liabilities.
b. subse3uent year)s transactions.
c. late unusual occurrences.
d. subse3uent eents.
1=.
easy
d
Which of the following is not a contingent liability with which an auditor is particularly
concerned?
a. 'ncome tax disputes
b. >otes receiable discounted
c. 0roduct warranties
d. "n auditor is concerned with each of the aboe.
11.
easy
d
"udit procedures related to contingent liabilities are initially focused on$
a. accuracy.
b. completeness.
c. existence.
d. occurrence.
1!.
easy
c
Which type of subse3uent eent re3uires consideration by management and ealuation by the
auditor?
a. :ubse3uent eents that hae a direct effect on the financial statements and re3uire
ad#ustment.
b. :ubse3uent eents that hae no direct effect on the financial statements but for which
disclosure is adisable.
c. %oth a and b.
d. >either a nor b.
1&.
easy
b
Wheneer subsequent events are used to ealuate the amounts included in the statements( care
must be ta,en to distinguish between conditions that existed at the balance sheet date and
those that come into being after the end of the year. The subse3uent information should not
be incorporated directly into the statements if the conditions causing the change in valuation$
a. too, place before year-end.
b. did not ta,e place until after year-end.
c. occurred both before and after year-end.
d. are reimbursable through insurance policies.
1*.
easy
b
"uditors will generally send a standard in3uiry letter to$
a. only those attorneys who hae deoted substantial time to client matters during the year.
b. eery attorney that the client has been inoled with in the current or preceding year( plus
any attorney the client engages on occasion.
c. those attorneys whom the client relies on for adice related to substantial legal matters.
d. none of the aboe.
!*-!
14.
easy
d
Who may identify matters to be included in a letter of in3uiry sent to a client)s legal counsel?
a. Company management.
b. "uditors.
c. Company)s legal counsel at the direction of company management.
d. "ll of the aboe.
16.
easy
d
Which of the following is not one of the three main reasons why it is essential that audit files be
thoroughly reiewed by another member of the audit firm at the completion of the audit?
a. To ealuate the performance of inexperienced personnel.
b. To counteract the bias that fre3uently enters into the auditor)s #udgment.
c. To ma,e sure that the audit meets the C0" firm)s standard of performance.
d. To ealuate the accuracy of the auditing firm)s time budget for the engagement.
17.
easy
b
Which of the following subse3uent eents is most li,ely to result in an adjustment to a
companys financial statements?
a. Merger or ac3uisition actiities.
b. %an,ruptcy 1due to deteriorating financial condition2 of a customer with an outstanding
accounts receiable balance.
c. 'ssuance of common stoc,.
d. "n uninsured loss of inentories due to a fire.
19.
easy
c
With which of the following client personnel would it generally not be appropriate to in3uire
about commitments or contingent liabilities?
a. Controller.
b. 0resident.
c. "ccounts receiable cler,.
d. ?ice president of sales.
1<.
easy
c
"t what stages of the audit must analytical procedures be used?
a. 0lanning and testing.
b. Testing and completion.
c. 0lanning and completion.
d. 0lanning( testing( and completion.
!=.
medium
d
Which of the following procedures and methods are important in assessing a company)s ability
to continue as a going concern?
a. 0erformance of analytical procedures directed at profitability( asset turnoer( and cash
flows.
b. @iscussions with management regarding future plans related to sales actiities( cost
controls( and mar,eting efforts.
c. Anowledge of the client)s business gained throughout the audit.
d. "ll of the aboe are important procedures and methods used in assessing going concern.
!1.
medium
a
'n3uiries of management regarding the possibility of unrecorded contingencies will not be
useful in uncoering$
a. management)s intentional failure to disclose existing contingencies.
b. a particular type of contingency which management has oerloo,ed.
c. when management does not comprehend accounting disclosure re3uirements.
d. all three of the aboe items.
!*-&
!!.
medium
b
Which of the following procedures might be useful in discoering a contingent liability for a
lawsuit that management is intentionally neglecting to disclose?
a. 'n3uiries 1orally and in writing2 of management.
b. "nalyBing legal expense and reiew inoices and statements from outside legal counsel.
c. .eiewing current and preious years) internal reenue agent reports.
d. 5btaining a letter of representation from management that it is aware of no undisclosed
contingent liabilities.
!&.
medium
d
Commitments include all but which of the following?
a. "greements to purchase raw materials.
b. 0ension plans.
c. "greements to lease facilities at set prices.
d. Cach of the aboe is a commitment.
!*.
medium
d
The standard letter of in3uiry to the client)s legal counsel should be prepared on$
a. plain paper 1no letterhead2 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 stationery and signed by a company official.
!4.
medium
d
Which of the following items would ordinarily not be included in the standard letter of in3uiry
to the client)s attorney?
a. " list( prepared by management( of pending threatened litigation of material amounts.
b. " re3uest that the attorney furnish information or comment about the li,elihood of an
unfaorable outcome of litigation.
c. " re3uest that the attorney furnish an estimate of the amount or range of the potential loss.
d. " re3uest that the attorney confirm the amount of outstanding fees which client owes for
legal serices.
!6.
medium
b
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. left undated.
!7.
medium
c
When should auditors generally assess a client)s ability to continue as a going concern?
a. Dpon completion of the audit.
b. @uring the planning stages of the audit.
c. Throughout the entire audit process.
d. @uring testing and completion phases of the audit.
!9.
medium
c
The audit procedures for the subse3uent eents reiew can be diided into two categories$ 112
procedures integrated as a part of the erification of year-end account balances( and 1!2 those
performed specifically for the purpose of discoering subse3uent eents. Which of the
following procedures is in category 1?
a. 'n3uiries of client regarding contingent liabilities.
b. 5btain a letter of representation written by client.
c. :ubse3uent period sales and purchases transactions are examined to determine whether the
cutoff is accurate.
d. .eiew #ournals and ledgers of year ! to determine the existence of any transaction related
to year 1.
!*-*
!<.
medium
a
The audit procedures for the subse3uent eents reiew can be diided into two categories$ 112
procedures normally integrated as a part of the erification of year-end account balances( and
1!2 those performed specifically for the purpose of discoering subse3uent eents. Which of the
following procedures is in category !?
a. Correspond with attorneys.
b. Test the collectibility of accounts receiable by reiewing subse3uent period cash receipts.
c. :ubse3uent period sales and purchases transactions are examined to determine whether the
cutoff is accurate.
d. Compare the subse3uent-period purchase price of inentory with the recorded cost as a
test of lower-of-cost-or-mar,et aluation.
&=.
medium
d
Which of the following is not a matter that is typically included in the letter of representation
obtained from an audit client?
a. "ailability of all financial records and related data.
b. "bsence of unrecorded transactions.
c. Compliance with aspects of contractual agreements that may affect the financial
statements.
d. "ssessment of management)s efficiency of decision ma,ing.
&1.
medium
c
:": >o. 4< re3uires the auditor to ealuate whether there is a substantial doubt about a client)s
ability to continue as a going concern for at least$
a. one 3uarter beyond the balance sheet date.
b. one 3uarter 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.
&!.
medium
a
:": >o. 4< re3uires auditors to ealuate whether there is a substantial doubt about a client)s
ability to continue as a going concern. 5ne of the most important types of eidence to assess the
going concern 3uestion is$
a. analytical procedures.
b. confirmations of creditors.
c. statistical sampling procedures.
d. in3uiries of client and its legal counsel.
&&.
medium
d
Which of the following statements regarding the letter of representation is not correct?
a. 't is prepared on the client)s letterhead.
b. 't is addressed to the C0" firm.
c. 't is signed by high-leel corporate officials( usually the president and chief financial
officer.
d. 't is optional( not re3uired( that the auditor obtain such a letter from management.
&*.
medium
c
'f an auditor concludes there are contingent liabilities( then he or she must ealuate the$
a. materiality of the potential liability.
b. nature of the disclosure to be included in the financial statements.
c. a and b.
d. neither a nor b.
&4.
medium
a
.efusal by a client to prepare and sign the representation letter would re3uire a1n2$
a. 3ualified opinion or a disclaimer.
b. aderse opinion or a disclaimer.
c. 3ualified or an aderse opinion.
d. un3ualified opinion with an explanatory paragraph.
!*-4
&6.
medium
d
" client representation letter is$
a. prepared on the client)s letterhead.
b. addressed to the C0" firm.
c. signed by high-leel officials 1e.g. the president and chief financial officer2.
d. all of the aboe.
&7.
medium
a
Which of the following is not a purpose of the client letter of representation?
a. To impress upon the audit firm its responsibility for the audit.
b. To impress upon management its responsibility for the financial statement assertions.
c. To remind management of potential misstatements or omissions in the financial
statements.
d. To document the responses from management to in3uiries about arious aspects of the
audit.
&9.
medium
d
Which of the following is not one of the categories of items included in the client letter of
representation?
a. :ubse3uent eents
b. Completeness of information
c. .ecognition( measurement( and disclosure
d. Materiality
&<.
medium
d
:": >o. << and :": >o. 4* re3uire the auditor to communicate all 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.
*=.
medium
c
The auditor is responsible for communicating significant internal control deficiencies to the
audit committee( or those charged with goernance. This communication$
a. may be oral or written.
b. must be oral.
c. must be written.
d. must be oral ia direct communication.
*1.
medium
a
Which of the following audit procedures would most li,ely assist an auditor in identifying
conditions and eents that may indicate there could be substantial doubt about an entity)s ability
to continue as a going concern?
a. .eiew compliance with the terms of debt agreements.
b. Confirmation of accounts receiable from principal customers.
c. .econciliation of interest expense with debt outstanding.
d. Confirmation of ban, balances.
*!.
medium
c
Which of the following statements is correct?
a. " letter of representation is documentation of management)s acceptance of responsibility
for the financial statements and is deemed to be reliable eidence.
b. " letter of representation is not deemed to be reliable eidence because of the potential
incompetence of management.
c. " letter of representation is not deemed to be reliable eidence because of the lac, of
independence of the preparers.
d. >one of the aboe is correct.
!*-6
*&.
medium
a
When a client will not permit in3uiry of outside legal counsel( the audit report will ordinarily
contain a1n2$
a. disclaimer of opinion.
b. 3ualified opinion.
c. standard un3ualified opinion.
d. un3ualified opinion with a separate explanatory paragraph.
**.
medium
d
Which of the following would be a subse3uent discoery of facts which would re3uire a
response by the auditor?
a. @iscoery of the inclusion of material nonexistent sales.
b. @iscoery of the failure to write off material obsolete inentory.
c. @iscoery of the omission of a material footnote.
d. Cach of the aboe would re3uire a response by the auditor.
*4.
medium
c
Which of the following auditing procedures is ordinarily performed last?
a. .eading minutes of the board of directors) meetings.
b. Confirming accounts payable.
c. 5btaining a client representation letter.
d. Testing the purchasing function.
*6.
medium
d
Which of the following is the most efficient audit procedure for the detection of unrecorded
liabilities at the balance sheet date?
a. 5btain an attorney)s letter from the client)s attorney.
b. Confirm large accounts payable balances at the balance sheet date.
c. Cxamine purchase orders issued for seeral days prior to the close of the year.
d. Compare cash disbursements in the subse3uent period with the accounts payable trial
balance at year-end.
*7.
medium
c
"s part of an audit( a C0" often re3uests a representation letter from the client. Which one of
the following is not a alid purpose of such a letter?
a. To proide audit eidence.
b. To emphasiBe to the client the client)s responsibility for the correctness of the financial
statements.
c. To satisfy the C0" by means of other auditing procedures when certain customary auditing
procedures are not performed.
d. To proide possible protection to the C0" against a charge of ,nowledge in cases where
fraud is subse3uently discoered to hae existed in the accounts.
*9.
medium
a
'n connection with the annual audit( which of the following is not a +subse3uent eents-
procedure?
a. .eiew aailable interim financial statements.
b. .ead aailable minutes of meetings of stoc,holders( directors( and committees and( for
meetings where minutes are not aailable( in3uire about matters dealt with at such
meetings.
c. Ma,e in3uiries with respect to the financial statements coered by the auditor)s preiously
issued report if new information has become aailable during the current examination that
might affect that report.
d. @iscuss with officers the current status of items in the financial statements that were
accounted for on the basis of tentatie( preliminary( or inconclusie data.
!*-7
*<.
medium
a
"n auditor performs interim wor, at arious times throughout the year. The auditor)s
subse3uent eents wor, should be extended to the date of$
a. the auditor)s report.
b. a post-dated footnote.
c. the next scheduled interim isit.
d. the final billing for audit serices rendered.
4=.
medium
c
Which eent that occurred after the end of the fiscal year under audit but prior to issuance of the
auditor)s report would not re3uire disclosure in the financial statements?
a. :ale of a bond or capital stoc, issue.
b. Eoss of plant or inentories as a result of fire or flood.
c. " significant decline in the mar,et price of the corporation)s stoc,.
d. :ettlement of litigation when the eent giing rise to the claim too, place after the balance
sheet date.
41.
medium
c
Which of the following determines the sufficiency of eidence?
a. Fenerally "ccepted "uditing :tandards.
b. :ecurities and Cxchange Commission regulations.
c. "uditor #udgment.
d. "dherence to the audit program.
4!.
medium
c
Which of the following material eents occurring subse3uent to the balance sheet date would
re3uire an ad#ustment to the financial statements before they could be issued?
a. Eoss of a plant as a result of a flood.
b. :ale of long-term debt or capital stoc,.
c. :ettlement of litigation in excess of the recorded liability.
d. Ma#or purchase of a business that is expected to double the sales olume.
4&.
medium
c
While there is no professional re3uirement to do so on audit engagements( C0"s fre3uently
issue a formal +management- letter to clients? The primary purpose of this letter is to proide$
a. eidence indicating whether the auditor is reasonably certain that internal accounting
control is operating as prescribed.
b. a permanent record of the internal accounting control wor, performed by the auditor
during the course of the engagement.
c. a written record of discussions between auditor and client concerning the auditor)s
obserations and suggestions for improements.
d. a summary of the auditor)s obserations that resulted from the auditor)s special study of
internal control.
4*.
challenging
c
'f the auditor determines that a subse3uent eent that affects the current period financial
statements occurred after fieldwor, was completed but before the audit report was issued(
what date1s2 may the auditor use on the report?
a. The date on which the last day of fieldwor, occurred.
b. The date of the subse3uent eent.
c. The date on which the last day of fieldwor, occurred and the date of the subse3uent eent.
d. b and c( but not a.
44.
challenging
d
Why must audit documentation be reiewed?
a. To ensure that the audit meets the C0" firm)s standard of performance.
b. To ealuate the performance of inexperienced personnel.
c. To counteract bias that often enters into the auditor)s #udgment.
d. "ll of the aboe are reasons for reiew of audit documentation.
!*-9
46.
challenging
d
'f the auditor concludes that there are contingent liabilities( he or she must ealuate 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 ,nown in some instances to be included in the
financial statements as an actual liability.
b. @isclosure may be unnecessary if the contingency is highly remote or immaterial.
c. ;re3uently( the C0" firm obtains a separate ealuation of the potential liability from its
own legal counsel rather than relying on management or management)s attorneys.
d. "nswers b and c are correct( but answer is not.
47.
challenging
d
The auditor)s responsibility for +reiewing the subse3uent eents- 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 effectie.
49.
challenging
b
The process of +final eidence accumulation- is always done late in the engagement. Which one
of the following would be done the earliest in the engagement?
a. ;inal analytical procedures.
b. :earch for contingent liabilities.
c. Caluate the going concern assumption.
d. "c3uire the client)s letter of representation.
4<.
challenging
d
Which of the following is not a reason why the auditor re3uests that the client proide a letter
of representation?
a. 0rofessional auditing standards re3uire the auditor to obtain a letter of representation.
b. 't impresses upon management its responsibility for the accuracy of the information in the
financial statements.
c. 't proides written documentation of the oral responses already receied to in3uiries of
management.
d. 't proides written documentation( which is a higher 3uality of eidence than
management)s oral responses to in3uiries.
6=.
challenging
a
Which of the following is not re3uired to be communicated to the audit committee or similarly
designated body under auditing standards?
a. "ll material frauds and illegal acts of a material nature.
b. @isagreements with management about the scope of the audit( applicability of accounting
principles( or wording of the audit report.
c. @ifficulties encountered in performing the audit( such as lac, of aailability of client
personnel and failure to proide necessary information.
d. "uditor)s responsibilities under generally accepted auditing standards( including
responsibility for ealuating internal control and the concept of reasonable rather than
absolute assurance.
61.
challenging
b
" C0" has receied an attorney)s letter in which no significant disagreements with the client)s
assessments of contingent liabilities were noted. The resignation of the client)s lawyer shortly
after receipt of the letter should alert the auditor that$
a. an aderse opinion will be necessary.
b. undisclosed unasserted claims may hae arisen.
c. the auditor must begin a completely new examination of contingent liabilities.
d. the attorney was unable to form a conclusion with respect to the significance of litigation(
claims( and assessments.
!*-<
6!.
challenging
b
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. .e3uest that client lawyers underta,e a reconsideration of matters of litigation( claims( and
assessments with which they were consulted during the period under examination.
b. .e3uest that client management send a letter of in3uiry to those lawyers with whom
management consulted concerning litigation( claims( and assessments.
c. .e3uest that client lawyers proide a legal opinion concerning the policies and procedures
adopted by management to identify( ealuate( and account for litigation( claims( and
assessments.
d. .e3uest 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.
6&.
challenging
d
"n attorney is responding to an independent auditor as a result of the client)s letter of in3uiry.
The attorney may appropriately limit the response to$
a. asserted claims and litigation.
b. asserted( oertly threatened( or pending claims and litigation.
c. items which hae an extremely high probability of being resoled to the client)s detriment.
d. matters to which the attorney has gien substantie attention in the form of legal
consultation or representation.
6*.
challenging
a
" company guarantees the debt of an affiliate. Which of the following best describes the audit
procedure that would ma,e the auditor aware of the guarantee?
a. .eiew minutes and resolutions of the board of directors.
b. .eiew prior year)s audit files with respect to such guarantees.
c. .eiew the possibility of such guarantees with the chief accountant.
d. .eiew the legal letter returned by the company)s outside legal counsel.
64.
challenging
b
Clise-Freer( EE0 is an affiliate of the audit client and is audited by another firm of auditors.
Which of the following is most li,ely to be used by the auditor to obtain assurance that all
guarantees of the affiliate)s indebtedness hae been detected?
a. :end the standard ban, confirmation re3uest to all of the client)s lender ban,s.
b. .eiew client minutes and obtain a representation letter.
c. Cxamine supporting documents for all entries in intercompany accounts.
d. 5btain written confirmation of indebtedness from the auditor of the affiliate.
66.
challenging
c
"n auditor must obtain written client representations that might be signed by all but which of
the following?
a. Treasurer
b. Chief financial officer
c. ?ice president of manufacturing
d. Chief executie officer
67.
challenging
c
"n auditor must obtain written client representations that normally should be signed by$
a. the treasurer and the internal auditor.
b. the president and the chairperson of the board.
c. the chief executie officer and the chief financial officer.
d. the corporate counsel and the audit committee chairperson.
!*-1=
69.
challenging
b
:ubse3uent eents affecting the realiBation of assets ordinarily will re3uire ad#ustments of the
financial statements under examination because such eents typically represent the$
a. culmination of conditions that existed at the balance sheet date.
b. discoery of new conditions occurring in the subse3uent eents period.
c. final estimates of losses relating to casualties occurring in the subse3uent eents period.
d. preliminary estimate of losses relating to new eents that occurred subse3uent to the
balance sheet date.
6<.
challenging
a
"n 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 subse3uent eents.
c. permit inclusion of a footnote captioned$ eent 1unaudited2 subse3uent to the date of the
auditor)s report.
d. assume responsibility for eents subse3uent to the issuance of the auditor)s report.
7=.
challenging
d
"fter an auditor has issued an audit report on a nonpublic entity( there is no obligation to ma,e
any further audit tests or in3uiries with respect to the audited financial statements coered by
that report unless$
a. material aderse eents occur after the date of the auditor)s report.
b. final determination or resolution was made of a contingency which had been disclosed in
the financial statements.
c. final determination or resolution was made on matters which had resulted in a
3ualification in the auditor)s report.
d. new information comes to the auditor)s attention concerning an eent that occurred prior
to the date of the auditor)s report that may hae affected the auditor)s report.
71.
challenging
c
" client has a calendar year-end. Eisted below are four eents that occurred after @ecember &1.
Which one of these subse3uent eents might result in ad#ustment of the @ecember &1 financial
statements?
a. :ale of a ma#or subsidiary.
b. "doption of accelerated depreciation methods.
c. Write-off of a substantial portion of inentory as obsolete.
d. Collection of <=G of the accounts receiable existing at @ecember &1.
7!.
challenging
b
The auditor)s responsibility with respect to eents 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 eents occurring in the subse3uent period and should
extend all detailed procedures through the last day of fieldwor,.
b. The auditor is responsible for determining that a proper cutoff has been made and
performing a general reiew of eents occurring in the subse3uent 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 eents occurring in the subse3uent period unless
these eents affect transactions recorded on or before the balance sheet date.
!*-11
Cssay Questions
7&.
easy
@istinguish between contingent liabilities and commitments.
"nswer$
Contingent liabilities are future obligations to an outside party for an un,nown amount
resulting from actiities that hae already ta,en place. Commitments are agreements to
commit the company to a set of fixed conditions in the future regardless of what happens
to profits or the economy as a whole.
7*.
easy
@iscuss the purposes of performing analytical procedures during the audit completion phase.
"nswer$
"nalytical procedures performed during the completion phase are useful as a final reiew
for material misstatements or financial problems not noted during other testing( and to help
the auditor ta,e a final ob#ectie loo, at the financial statements.
74.
easy
With what types of contingencies might an auditor be concerned?
"nswer$
The auditor is generally concerned with contingencies arising from pending litigation for
patent infringement( income tax disputes( product warranties( notes receiable discounted(
guarantees of obligations of others( and unused balances of outstanding letters of credit.
76.
medium
What are the three re3uired conditions for a contingent liability to exist?
"nswer$
1. There is potential for future payment to an outside party or the impairment of an asset
that resulted from an existing condition.
!. There is uncertainty about the amount of the future payment or impairment.
&. The outcome will be resoled by some future eent or eents.
77.
medium
Eist four contingent liabilities that auditors are concerned about in most instances.
"nswer$
0ending litigation for patent infringement( product liability or other actionsH income tax
disputesH product warrantiesH notes receiable discountedH guarantees of obligation of
othersH and unused balances of outstanding letters of credit.
79.
medium
CharacteriBe the auditor)s role in preparing the financial statements.
"nswer$
The auditor acts in the role of adisor when preparing the financial statements( but
management retains the final and ultimate responsibility for approing the issuance of the
statements.
!*-1!
7<.
medium
:tate the two primary types of subse3uent eents that re3uire consideration by management and
ealuation by the auditor( and gie two examples of each type.
"nswer$
Cents that hae a direct effect on the financial statements and re3uired ad#ustment.
Cxamples include declaration of ban,ruptcy by a customer with an outstanding
accounts receiable balance due to deteriorating financial conditionH settlement of
litigation at an amount different from the amount recorded on the boo,s.
Cents that hae no direct effect on the financial statements but for which disclosure
is adisable. Cxamples include a decline in the mar,et alue of securities held for
temporary inestment or resale during the subse3uent periodH issuance of bonds or
e3uity securities during the subse3uent period.
9=.
medium
@iscuss three audit procedures commonly used to search for contingent liabilities.
"nswer$
'n3uire of management 1orally and in writing2 about the possibility of unrecorded
contingencies.
.eiew current and preious years) internal reenue agent reports for income tax
settlements.
.eiew the minutes of directors) and stoc,holders) meetings for indications of
lawsuits or other contingencies.
"nalyBe legal expense for the period under audit( and reiew inoices and statements
from legal counsel for indications of contingent liabilities.
5btain a letter from each ma#or attorney performing legal serices for the client as to
the status of pending litigation or other contingent liabilities.
.eiew audit files for any information that may indicate a potential contingency.
Cxamine letters of credit in force as of the balance sheet date and obtain a
confirmation of the used and unused balance.
91. 1:5I2
medium
@iscuss the three matters which :arbanes-5xley re3uires auditors of public companies to report
to the audit committee.
"nswer$
The three items that must be reported to the audit committee are$
"ll critical accounting policies and practices to be used.
"ll alternatie treatments of financial information within generally accepted
accounting principles that hae been discussed with management( ramifications of the
use of such alternatie disclosures and treatments( and the treatment preferred by the
auditor( and
5ther material written communications between the auditor and management( such as
any management letter or schedule of unad#usted differences.
9!.
medium
:tate the three purposes of the client letter of representation.
"nswer$
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 in3uiries about arious aspects of the
!*-1&
audit.
9&.
medium
Eist four specific matters that should be included in a client representation letter.
"nswer$
Management)s ac,nowledgment of its responsibility for the fair presentation in the
statements of financial position( results of operations( and cash flows in conformity
with generally accepted accounting principles or other comprehensie basis of
accounting.
"ailability of all financial records and related data.
Completeness and aailability of all minutes of meetings of stoc,holders( directors(
and committees of directors.
'nformation concerning related-party transactions and related amounts receiable or
payable.
0lans or intentions that may affect the carrying alue or classification of assets or
liabilities.
@isclosure of compensating balances or other arrangements inoling restrictions on
cash balances( and disclosure of line-of-credit or similar arrangements.
9*. 10ublic2
medium
0roide seeral representations that auditors of public companies may see, from management
regarding internal control.
"nswer$
0ossible representations include$
Management)s ac,nowledgement of its responsibilities for establishing and
maintaining effectie internal control oer financial reporting.
Management)s conclusion about the effectieness of internal control oer financial
reporting as of the end of the fiscal period.
@isclosure to the auditor of all deficiencies in the design or operation of internal
control oer financial reporting.
Management)s ,nowledge of any material fraud or other fraud inoling senior
management or other employees who hae a significant role in the company)s internal
control oer financial reporting.
94.
challenging
:tate three lists or re3uests that should be included in a standard +in3uiry of attorney- letter.
"nswer$
" list( prepared by management( of 112 pending threatened litigation and 1!2 asserted
or unasserted claims or assessments with which the attorney has had significant
inolement. "n alternatie is for the letter to re3uest the attorney to prepare the list.
" re3uest that the attorneys furnish information or comment about the progress of
each item listed( the legal action the client intends to ta,e( the li,elihood of an
unfaorable outcome( and an estimate of the amount or range of the potential loss.
" re3uest for the identification of any unlisted pending or threatened legal actions or a
statement that the client)s list is complete.
" statement by the client informing the attorney of his or her responsibility to inform
management wheneer in the attorney)s #udgment there is a legal matter re3uiring
disclosure in the financial statements. The letter of in3uiry should also re3uest the
attorney to respond directly to the auditor that he or she understands this
responsibility.
" re3uest that the attorney identifies and describes the nature of any reasons for any
limitations in the response.
!*-1*
96.
challenging
%esides the search for contingent liabilities and the reiew for subse3uent eents( the auditor
has four important final eidence accumulation responsibilities( all of which are re3uired by
current professional auditing standards. @iscuss each of these four responsibilities.
"nswer$
;inal analytical procedures performed as a final reiew for material misstatements or
financial problems and to help the auditor ta,e a final ob#ectie loo, at the financial
statements.
Caluate the going concern assumption.
5btain a client representation letter documenting management)s most important oral
representations during the audit.
.ead information included in published annual reports pertaining directly to the
financial statements.
5ther 5b#ectie "nswer ;ormat Questions
97.
medium
The fieldwor, for the @ecember &1( !==7 audit of :chmidt Corporation ended on March 17(
!==9. The financial statements and auditor)s report were issued and mailed to stoc,holders on
March !<( !==9. 'n each of the material situations 11 through 42 below( indicate the appropriate
action 1a( b( c( d( or e2. The possible actions are as follows$
a. "d#ust the @ecember &1( !==7 financial statements.
b. @isclose the information in a footnote in the @ecember &1( !==7 financial statements.
c. .e3uest the client reise and reissue the @ecember &1( !==7 financial statements. The
reision should inole an ad#ustment to the @ecember &1( !==7 financial statements.
d. .e3uest the client reise and reissue the @ecember &1( !==7 financial statements. The
reision should inole the addition of a footnote( but no ad#ustment( to the @ecember &1(
!==7 financial statements.
e. >o action is re3uired.
The situations are as follows$
d 1. 5n "pril 4( !==9( you discoered that( on ;ebruary 16( !==9( a flood destroyed
the entire uninsured inentory in one of :chmidt)s warehouses.
b !. 5n ;ebruary 17( !==9( you discoered that( on ;ebruary 16( !==9( a flood
destroyed the entire uninsured inentory in one of :chmidt)s warehouses.
a &. 5n ;ebruary 17( !==9( you discoered that( on >oember &=( !==7( a flood
destroyed the entire uninsured inentory in one of :chmidt)s warehouses.
e *. 5n "pril 4( !==9( you discoered that( on March &=( !==9( a fire destroyed one
of :chmidt)s 1& plants.
c 4. 5n "pril 7( !==9( you discoered that a debtor of :chmidt went ban,rupt on
January 6( !==9( due to gradual declining financial health.
!*-14
99.
challenging
The fieldwor, for the @ecember &1( !==7 audit of Tribble Corporation ended on March 17(
!==9. The financial statements and auditor)s report were issued and mailed to stoc,holders on
March !<( !==9. 'n each of the material situations 11 through 42 below( indicate the appropriate
action 1a( b( c( d( or e2. The possible actions are as follows$
a. "d#ust the @ecember &1( !==7 financial statements.
b. @isclose the information in a footnote in the @ecember &1( !==7 financial statements.
c. .e3uest the client reise and reissue the @ecember &1( !==7 financial statements. The
reision should inole an ad#ustment to the @ecember &1( !==7 financial statements.
d. .e3uest the client reise and reissue the @ecember &1( !==7 financial statements. The
reision should inole the addition of a footnote( but no ad#ustment( to the @ecember &1(
!==7 financial statements.
e. >o action is re3uired.
The situations are as follows$
b 1. 5n January 16( !==9( a lawsuit was filed against Tribble for a patent infringement
action that allegedly too, place in early !==4. 'n the opinion of Tribble)s
attorneys( there is a reasonable 1but not probable2 danger of a significant loss to
Tribble.
a !. 5n ;ebruary 1<( !==9( Tribble settled a lawsuit out of court that had originated in
!==! and is currently listed as a contingent liability.
e &. 5n March &=( !==9( Tribble settled a lawsuit out of court that had originated in
!==* and is currently listed as a contingent liability.
b *. 5n ;ebruary !( !==9( you discoered an uninsured lawsuit against Tribble that
had originated on "ugust &=( !==7.
d 4. 5n "pril 7( !==9( you discoered that a debtor of Tribble went ban,rupt on
January !!( !==9( due to a ma#or uninsured fire that occurred on January !( !==9.
!*-16
9<.
medium
Match seen of the terms 1a-p2 with the descriptionKdefinitions proided below 11-72$
a. Commitments
b. Completing the engagement chec,list
c. Contingent liability
d. @ual-dated audit report
e. ;inancial statement disclosure chec,list
f. 'ndependent reiew
g. 'n3uiry of client)s attorneys
h. Eetter of representation
i. 5ther information in annual reports
#. .eiew for subse3uent eents
,. :ubse3uent eents
l. Dnad#usted misstatement wor,sheet
m. Management letter
n. 0ending claim
o. Dnasserted claim
p. "udit documentation reiew
f 1. " reiew of the financial statements and the entire set of audit files by an
independent reiewer to whom the audit team must #ustify the eidence
accumulated and the conclusions reached.
c !. " potential future obligation to an outside party for an un,nown amount
resulting from actiities that hae already ta,en place.
h &. " written communication from the client to the auditor formaliBing statements
that the client has made about matters pertinent to the audit.
o *. " potential legal claim against a client where the condition for a claim exists but
no claim has been filed.
, 4. Transactions that occurred after the balance sheet date( which affect the fair
presentation or disclosure of the statements being audited.
a 6. "greements that the entity will hold to a fixed set of conditions( such as the
purchase or sale of merchandise at a stated price.
d 7. The use of one audit report date for normal subse3uent eents and a later date
for one or more subse3uent eents.
<=.
easy
b
"n independent reiew must be performed of all audits.
a. True
b. ;alse
<1.
easy
a
" lawsuit has been filed against your client. 'f( in the opinion of legal counsel( the li,elihood
your client will lose the lawsuit is remote( no financial statement accrual or disclosure of the
potential loss is re3uired.
a. True
b. ;alse
<!.
easy
a
Current professional auditing standards re3uire the performance of analytical procedures during
the planning and completion phases of the audit.
a. True
b. ;alse
!*-17
<&.
easy
b
Current professional auditing standards re3uire the performance of analytical procedures during
the testing phase of the audit.
a. True
b. ;alse
<*.
easy
a
'f an auditor discoers that preiously issued financial statements are misleading( the most
desirable approach to follow is to re3uest that the client issue an immediate reision of the
financial statements containing an explanation of the reasons for the reision.
a. True
b. ;alse
<4.
easy
a
The issuance of bonds by the client subse3uent to year-end would re3uire a footnote disclosure
in( but no ad#ustment to( the financial statements under audit.
a. True
b. ;alse
<6.
medium
a
:": 4< directs the auditor)s assessment of going-concern issues.
a. True
b. ;alse
<7.
medium
b
"uditors are not re3uired to ealuate the going concern assumption as part of each audit.
a. True
b. ;alse
<9.
medium
a
"lthough 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.
a. True
b. ;alse
<<. 10ublic2
medium
a
"uditors of public companies must obtain certain representations from management regarding
internal control oer financial reporting.
a. True
b. ;alse
1==.
medium
a
Current professional auditing standards ma,e it clear that management( not the auditor( is
responsible for identifying and deciding the appropriate accounting treatment for contingent
liabilities.
a. True
b. ;alse
1=1.
medium
b
"t the completion of the audit( management is typically as,ed to ma,e a written statement as a
part of the engagement letter that it is aware of no undisclosed contingent liabilities.
a. True
b. ;alse
1=!.
medium
a
When preparing a standard in3uiry of client)s attorney letter( the client)s letterhead should be
used( and the letter should be signed by the client company)s officials.
a. True
b. ;alse
1=&.
medium
b
'n a standard in3uiry of client)s attorney letter( the attorney is re3uested to communicate about
contingencies up to the balance sheet date.
a. True
b. ;alse
!*-19
1=*.
medium
b
'f an attorney refuses to proide the auditor with information about material existing lawsuits or
unasserted claims( current professional standards re3uire that the auditor issue an aderse
opinion to reflect the lac, of aailable eidence.
a. True
b. ;alse
1=4.
medium
b
"uditors are re3uired to communicate orally with the audit committee about internal control
wea,nesses.
a. True
b. ;alse
1=6.
medium
a
"uditors must communicate in writing about internal control wea,nesses to the audit committee
or those charged with goernance.
a. True
b. ;alse
1=7.
medium
b
"uditors are re3uired to obtain a letter of representation that describes management)s planned
solutions to all internal control wea,nesses identified during an audit.
a. True
b. ;alse
1=9.
medium
b
The letter of representation is prepared on the C0" firm)s letterhead( addressed to the client)s
chief executie officer( and signed by the audit engagement partner.
a. True
b. ;alse
1=<.
medium
a
'f the client refuses to prepare and sign a letter of representation( the auditor would be re3uired
to issue either a 3ualified opinion or a disclaimer of opinion.
a. True
b. ;alse
11=.
medium
a
%ecause a client representation letter is a written statement from a non-independent source( it
cannot be regarded as reliable eidence.
a. True
b. ;alse
111.
medium
b
'f( during the completion phase of the audit( the auditor determines that he or she has not
obtained sufficient eidence to draw a conclusion about the fairness of the client)s financial
statements( there are two choices$ additional eidence must be obtained( or either a 3ualified or
an aderse opinion must be issued.
a. True
b. ;alse
11!.
medium
a
Client representation letters are re3uired by professional auditing standards( whereas
management letters are optional.
a. True
b. ;alse
11&.
medium
b
:ubse3uent eents which re3uire ad#ustment to the financial statements proide additional
information about significant conditionsKeents which did not exist at the balance sheet date.
a. True
b. ;alse
!*-1<
11*.
medium
b
:ubse3uent eents for which disclosure( but no ad#ustment( is re3uired proide information
about significant eentsKconditions which existed at the balance sheet date.
a. True
b. ;alse
114.
challenging
a
When testing for contingent liabilities( the primary ob#ectie at the initial stage of the tests is to
determine the existence of contingencies.
a. True
b. ;alse
116.
challenging
b
:ubse3uent discoeries of facts re3uiring the reissuance of financial statements arise from
eents occurring after the date of the auditor)s report.
a. True
b. ;alse
!*-!=