AUDITING AND ASSURANCE SERVICES AN INTEGRATED APPROACH 16TH EDITION – TEST BANK

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AUDITING AND ASSURANCE SERVICES AN INTEGRATED APPROACH 16TH EDITION – TEST BANK

Auditing and Assurance Services, 16e (Arens/Elder/Beasley)

Chapter 5   Legal Liability

 

5.1   Learning Objective 5-1

 

1) Which of the following factors does not contribute to the number of lawsuits against auditors?

  1. A) large civil court judgments against CPA firms awarded in a few cases
  2. B) growing awareness of the responsibilities of public accountants by users of financial statements
  3. C) the simplicity of auditing and accounting functions
  4. D) an increased consciousness by the SEC for its responsibility for protecting investors’ interests

Answer:  C

Terms:  Major factors that have contributed to the recent increase in the number of lawsuits against auditors

Diff:  Easy

Objective:  LO 5-1

AACSB:  Reflective thinking

 

2) Discuss three major factors that have contributed to the recent increase in the number of lawsuits against auditors and the size of awards to plaintiffs.

Answer:  Major factors include:

  • The growing awareness of the responsibilities of public accountants by users of financial statements
  • An increased consciousness on the part of the Securities and Exchange Commission regarding its responsibility for protecting investors’ interests
  • The complexity of auditing and accounting functions caused by the increasing size of businesses, the globalization of business, and the complexities of business operations and financing transactions
  • The tendency of society to accept lawsuits by injured parties against anyone who might be able to provide compensation, regardless of who was at fault, coupled with joint and several liability doctrine
  • The global recession and tough economic times result in business failures, which prompt stakeholders to seek restitution from others, including external auditors
  • Large civil court judgments against CPA firms awarded in a few cases
  • The willingness of CPA firms to settle legal problems out of court to avoid costly legal fees and adverse publicity, rather than pursuing resolution through the judicial process
  • The difficulty judges and jurors have understanding and interpreting technical accounting and auditing matters

 

Terms:  Major factors that have contributed to the recent increase in the number of lawsuits against auditors

Diff:  Moderate

Objective:  LO 5-1

AACSB:  Reflective thinking

 

3) The auditor generally owes a duty of care to third parties who are part of a limited group of persons whose reliance is “foreseen” by the auditor.

Answer:  TRUE

Terms:  Liability to clients under common law

Diff:  Moderate

Objective:  LO 5-1

AACSB:  Reflective thinking

 

5.2   Learning Objective 5-2

 

1) A(n) ________ failure occurs when an auditor issues an erroneous opinion because it failed to comply with requirements of auditing standards.

  1. A) business
  2. B) audit
  3. C) ethics
  4. D) process

Answer:  B

Terms:  Failure which occurs when an auditor issues an erroneous opinion

Diff:  Easy

Objective:  LO 5-2

AACSB:  Reflective thinking

 

2) The expectation gap

  1. A) exists between the auditor and the SEC.
  2. B) exists because auditors guarantee the accuracy of the financial statements.
  3. C) often results in unwarranted lawsuits against the auditor.
  4. D) is a legal concept supported by the federal courts.

Answer:  C

Terms:  Expectation gap

Diff:  Moderate

Objective:  LO 5-2

AACSB:  Reflective thinking

 

3) Which of the following is an accurate statement regarding audit risk, audit failure, and business failure?

  1. A) Audit risk is always avoidable if the audit is conducted in accordance with generally accepted auditing standards.
  2. B) Because auditors gather evidence on a test basis, and because well-concealed frauds are difficult to detect, audit risk is unavoidable.
  3. C) Legal precedent makes it easy to determine who has the right to recover losses in the event of an audit failure.
  4. D) A business failure will always result in an audit failure.

Answer:  B

Terms:  Distinguish among business failure, audit failure, and audit risk

Diff:  Moderate

Objective:  LO 5-2

AACSB:  Reflective thinking

 

4) Distinguish between what is meant by business failure and audit failure.

Answer:  Business failure occurs when a business is unable to repay its lenders or meet expectations of its investors because of economic or business conditions, such as recession, poor management decisions, or unexpected competition in the industry. Audit failure occurs when the auditor issues an incorrect audit opinion because it failed to comply with the requirements of auditing standards.

Terms:  Business failure and audit failure

Diff:  Easy

Objective:  LO 5-2

AACSB:  Reflective thinking

 

5) Audit risk is the risk there will be an audit failure for a given audit engagement.

Answer:  FALSE

Terms:  Audit risk

Diff:  Moderate

Objective:  LO 5-2

AACSB:  Reflective thinking

 

6) The term “audit failure” refers to the situation when the auditor has followed auditing standards yet still fails to discover that the client’s financial statements are materially misstated.

Answer:  FALSE

Terms:  Audit failure

Diff:  Moderate

Objective:  LO 5-2

AACSB:  Reflective thinking

 

5.3   Learning Objective 5-3

 

1) In the performance of an audit, a CPA

  1. A) is legally liable for detecting an immaterial client fraud.
  2. B) must strictly follow GAAP for privately held clients.
  3. C) must exercise constructive professional care in the performance of their audit responsibilities.
  4. D) must exercise due professional care in the performance of their audit responsibilities.

Answer:  D

Terms:  Prudent person concept; due professional care

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

 

2) If an auditor fails to fulfill a certain requirement in the contract, they may be guilty of

  1. A) contract fraud.
  2. B) breach of contract.
  3. C) constructive fraud.
  4. D) criminal neglect.

Answer:  B

Terms:  Liability when auditors fail to exercise due care

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

3) In the case of an audit, recklessness is present if the auditor knew an adequate audit was not done but still issued an opinion, even though there was no intent to deceive financial statement users. This description is the legal term for

  1. A) ordinary negligence.
  2. B) gross negligence.
  3. C) constructive fraud.
  4. D) fraud.

Answer:  C

Terms:  Prudent person concept; due professional care

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

4) The standard of due care to which the auditor is expected to adhere to in the performance of the audit is referred to as the

  1. A) prudent person concept.
  2. B) common law doctrine.
  3. C) constructive care concept.
  4. D) vigilant person concept.

Answer:  A

Terms:  Standard of due care

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

 

 

5) Auditors may be liable to their clients if they are found guilty of

  1. A)
Ordinary negligence Gross negligence
Yes Yes

 

  1. B)
Ordinary negligence Gross negligence
No No

 

  1. C)
Ordinary negligence Gross negligence
Yes No

 

  1. D)
Ordinary negligence Gross negligence
No Yes

 

Answer:  A

Terms:  Auditor liability to clients

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

6) Under the laws of agency, partners of a CPA firm may be liable for the work of others on whom they rely. This would not include

  1. A) employees of the CPA firm.
  2. B) employees of the audit client.
  3. C) other CPA firms engaged to do part of the audit work.
  4. D) specialists employed by the CPA firm to provide technical advice on the audit.

Answer:  B

Terms:  Liability for the acts of others

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

7) “Absence of reasonable care that can be expected of a person in a set of circumstances” defines

  1. A) pecuniary negligence.
  2. B) gross negligence.
  3. C) extreme negligence.
  4. D) ordinary negligence.

Answer:  D

Terms:  Absence of reasonable care

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

8) An example of a breach of contract would likely include

  1. A) an auditor’s refusal to return the client’s general ledger book until the client paid last year’s audit fees.
  2. B) a bank’s claim that an auditor had a duty to uncover material errors in financial statements that had been relied on in making a loan.
  3. C) a CPA firm’s failure to complete an audit on the agreed-upon date because the firm had a backlog of other work which was more lucrative.
  4. D) an auditor’s claim that the client staff is unqualified.

Answer:  C

Terms:  Breach of contract

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

9) Privity of contract exists between

  1. A) auditor and the federal government.
  2. B) auditor and third parties.
  3. C) auditor and client.
  4. D) auditor and client attorney.

Answer:  C

Terms:  Privity of contract

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

10) An individual who is not party to the contract between a CPA and the client, but who is known by both and is intended to receive certain benefits from the contract is known as

  1. A) a third party.
  2. B) a common law inheritor.
  3. C) a tort.
  4. D) a third-party beneficiary.

Answer:  D

Terms:  Individual who is not a party to the contract between a CPA and client

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

11) Laws that have been passed by the U.S. Congress and other governmental units are

  1. A) statutory laws.
  2. B) judicial laws.
  3. C) federal laws.
  4. D) common laws.

Answer:  A

Terms:  Laws passed through governmental units

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

12) The assessment against a defendant of the full loss suffered by a plaintiff regardless of the extent to which other parties shared in the wrongdoing is called

  1. A) separate and proportionate liability.
  2. B) shared liability.
  3. C) unitary liability.
  4. D) joint and several liability.

Answer:  D

Terms:  Assessment against a defendant of the full loss suffered by a plaintiff

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

13) The assessment against a defendant of that portion of the damage caused by the defendant’s negligence is called

  1. A) separate and proportionate liability.
  2. B) joint and several liability.
  3. C) shared liability.
  4. D) unitary liability.

Answer:  A

Terms:  Assessment against a defendant of that portion of the damages

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

14) Fraud occurs when

  1. A) a misstatement is made and there is both knowledge of its falsity and the intent to deceive.
  2. B) a misstatement is made and there is knowledge of its falsity but no intent to deceive.
  3. C) the auditor lacks even slight care in the performance in performing the audit.
  4. D) the auditor has an absence of reasonable care in the performance of the audit.

Answer:  A

Terms:  Fraud and errors

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

15) Which of the following most accurately describes constructive fraud?

  1. A) absence of reasonable care
  2. B) lack of slight care
  3. C) knowledge and intent to deceive
  4. D) extreme or unusual negligence without the intent to deceive

Answer:  D

Terms:  Constructive fraud

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

 

16) Which of the following most accurately describes fraud?

  1. A) absence of reasonable care
  2. B) lack of slight care
  3. C) knowledge and intent to deceive
  4. D) extreme or unusual negligence without the intent to deceive

Answer:  C

Terms:  Fraud

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

 

17) A third-party beneficiary is one which

  1. A) has failed to establish legal standing before the court.
  2. B) does not have privity of contract and is unknown to the contracting parties.
  3. C) does not have privity of contract, but is known to the contracting parties and intended to benefit under the contract.
  4. D) may establish legal standing before the court after a contract has been consummated.

Answer:  C

Terms:  Third-party beneficiary

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

18) If the CPA negligently failed to properly prepare and file a client’s tax return, the CPA may be liable for

  1. A) the penalties the client owes the IRS.
  2. B) the penalties and interest the client owes.
  3. C) the penalties and interest the client owes, plus the tax preparation fee the CPA charged.
  4. D) the penalties and interest, the tax preparation fee, and the amount of tax that was underpaid.

Answer:  C

Terms:  Liability when a CPA negligently failed to properly prepare and file tax return

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

 

19) Constructive fraud

  1. A) is also known as recklessness.
  2. B) requires an intent to deceive.
  3. C) involves collusion with the client.
  4. D) is also known as breach of contract.

Answer:  A

Terms:  Constructive fraud

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Analytic thinking

 

 

20) Which of the following statements is true?

  1. A)
Gross negligence may constitute constructive fraud Fraud requires the intent to deceive All fraud should be detected during audit
Yes Yes No

 

  1. B)
Gross negligence may constitute constructive fraud Fraud requires the intent to deceive All fraud should be detected during audit
No Yes No

 

  1. C)
Gross negligence may constitute constructive fraud Fraud requires the intent to deceive All fraud should be detected during audit
Yes No Yes

 

  1. D)
Gross negligence may constitute constructive fraud Fraud requires the intent to deceive All fraud should be detected during audit
No No No

 

Answer:  A

Terms:  Gross negligence, fraud, and constructive fraud

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

21) The laws that have been developed through court decisions are called

  1. A) common laws.
  2. B) criminal laws.
  3. C) statutory laws.
  4. D) civil laws.

Answer:  A

Terms:  Common law

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

 

22) Which of the following is a true statement regarding CPAs’ liability?

  1. A) The amounts assessed under joint and several liability will not differ significantly from the amounts assessed under separate and proportionate liability.
  2. B) When lawsuits are brought under the federal securities laws, the joint and several liability approach will always apply.
  3. C) If one owner was directly involved in the actions of the owner causing the liability, the personal assets of neither owner can be subject to the damages that arise.
  4. D) Under the federal statutes, the amount of damages under separate and proportionate liability can be increased if the main defendant is insolvent.

Answer:  D

Terms:  Assessment against a defendant of that portion of the damages

Diff:  Challenging

Objective:  LO 5-3

AACSB:  Reflective thinking

 

23) The legal term for when an auditor issues an audit opinion, knowing that an adequate audit was not performed, is a

  1. A) breach of contract.
  2. B) tort action for negligence.
  3. C) constructive fraud.
  4. D) fraud.

Answer:  C

Terms:  Constructive fraud

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

24) Define ordinary negligence, gross negligence, and constructive fraud.

Answer:  Ordinary negligence is the absence of reasonable care that can be expected of a person is a set of circumstances. For auditors, it is in terms of what other competent auditors would have done in the same situation.

 

Gross negligence is the lack of even slight care, tantamount to reckless behavior, that can be expected of a person in a set of circumstances. Some states do not distinguish between ordinary and gross negligence.

 

Constructive fraud is the existence of extreme or unusual negligence even though there was no intent to deceive or to do harm. It is also termed recklessness. In an audit, recklessness is present if the auditor knew an adequate audit was not done but still issued an opinion, even though there was no intention of deceiving statement users.

Terms:  Ordinary negligence, gross negligence, and constructive fraud

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

 

25) An important concept in contract law for accountants to understand is the “third-party beneficiary doctrine.” Explain and give an example.

Answer:  A third party who does not have privity of contract but is known to the contracting parties and is intended to have certain rights and benefits under the contract. Example: bank has a large loan outstanding at the balance sheet date and requires an audit as part of the loan agreement.

Terms:  Contract law; Third-party beneficiary doctrine

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

26) Distinguish between constructive fraud and fraud.

Answer:  Constructive fraud is the existence of extreme or unusual negligence even though there was no intent to deceive or do harm. In contrast, fraud occurs when a misstatement is made and there is both knowledge of its falsity and the intent to deceive.

Terms:  Constructive fraud

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

 

27) Distinguish between “joint and several liability” and “separate and proportionate liability.”

Answer:  Under joint and several liability, the defendant can be assessed the full loss suffered by the plaintiff, regardless of the extent to which other parties shared in the wrongdoing. In contrast, under separate and proportionate liability, the defendant is assessed that portion of the damage caused by the defendant’s negligence.

Terms:  Joint and several liability and separate and proportionate liability

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

 

28) Match seven of the legal terms (a-j) with the definitions provided below (1-7):

 

  1. common law
  2. constructive fraud
  3. breach of contract
  4. joint and several liability
  5. ordinary negligence
  6. third-party beneficiary
  7. gross negligence
  8. statutory law
  9. fraud
  10. separate and proportionate liability

 

________ 1. laws that have been passed by the U.S. Congress and other governmental units

 

________ 2. absence of reasonable care that can be expected of a person in a set of circumstances

 

________ 3. lack of even slight care, tantamount to reckless behavior that can be expected of a person

 

________ 4. the assessment against a defendant of that portion of the damage caused by the defendant’s negligence

 

________ 5. failure of one or both parties in a contract to fulfill the requirements of the contract

 

________ 6. the assessment against a defendant of the full loss suffered by a plaintiff regardless of the extent to which other parties shared in the wrongdoing

 

________ 7. existence of extreme or unusual negligence even though there was no intent to deceive or do harm; also termed recklessness

Answer:

  1. h
  2. e
  3. g
  4. j
  5. c
  6. d
  7. b

Terms:  Constructive fraud; Breach of contract; Joint and several liability; Separate and proportionate liability; Gross negligence; Ordinary negligence; Statutory law

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

 

 

29) The standard of due care to which the auditor is expected to be held is referred to as the prudent person concept.

Answer:  TRUE

Terms:  Standard of due care; Prudent person concept

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

30) In a CPA firm operating as a limited liability partnership (LLP), the liability for one partner’s actions does not extend to another partner’s personal assets.

Answer:  TRUE

Terms:  CPA firm operating as a limited liability partnership

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

31) In a CPA firm operating as a limited liability partnership (LLP), the liability for one partner’s actions extends to the firm’s assets.

Answer:  TRUE

Terms:  CPA firm operating as a limited liability partnership

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

32) Statutory laws are laws that have been developed through court decisions rather than through the U.S. Congress and other governmental units.

Answer:  FALSE

Terms:  Statutory laws

Diff:  Easy

Objective:  LO 5-3

AACSB:  Reflective thinking

 

33) When an auditor has failed to conduct an adequate audit, liability may depend on the level of negligence.

Answer:  TRUE

Terms:  Liability and level of negligence

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

 

34) Several states have statutes that permit privileged communication between the client and auditor, allowing a CPA to refuse to testify in state and federal courts.

Answer:  FALSE

Terms:  CPA and privileged communication

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

 

35) Gross negligence is the existence of extreme or unusual negligence with the intent to deceive.

Answer:  FALSE

Terms:  Gross negligence

Diff:  Moderate

Objective:  LO 5-3

AACSB:  Reflective thinking

5.4   Learning Objective 5-4

 

1) The principal issue in cases involving alleged negligence is usually

  1. A) if an engagement letter was issued.
  2. B) the level of care required.
  3. C) if fraud was committed by upper-level management.
  4. D) whether the auditor is liable under civil or criminal laws.

Answer:  B

Terms:  Level of care; Negligence

Diff:  Easy

Objective:  LO 5-4

AACSB:  Reflective thinking

 

2) Which of the auditor’s defenses against client suits contends no implied or expressed contract?

  1. A) lack of duty
  2. B) non-negligent performance
  3. C) contributory negligence
  4. D) absence of causal connections

Answer:  A

Terms:  Auditors’ defenses against lawsuits

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

 

3) In connection with the audit of financial statements, an independent auditor could be responsible for failure to detect a material fraud if

  1. A) statistical sampling techniques were not used on the audit engagement.
  2. B) the auditor planned the audit in a negligent manner.
  3. C) accountants performing important parts of the work failed to discover a close relationship between the treasurer and the cashier.
  4. D) the fraud was perpetrated by one employee who circumvented the existing internal controls.

Answer:  B

Terms:  Independent auditor could be responsible for failure to detect material fraud

Diff:  Easy

Objective:  LO 5-4

AACSB:  Reflective thinking

 

 

4) Which of the following is an illustration of liability to clients under common law?

  1. A) A client sues the auditor for not discovering a theft of assets by an employee.
  2. B) A bank sues the auditor for not discovering that the borrower’s financial statements are misstated.
  3. C) A combined group of stockholders sues the auditor for not discovering materially misstated financial statements.
  4. D) The federal government prosecutes the auditor for knowingly issuing an incorrect audit report.

Answer:  A

Terms:  Liability to clients under common law

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

5) Which of the following is an illustration of liability under the federal securities acts?

  1. A) A client sues the auditor for not discovering a theft of assets by an employee.
  2. B) A bank sues the auditor for not discovering that the borrower’s financial statements are misstated.
  3. C) A combined group of stockholders sues the auditor for not discovering materially misstated financial statements.
  4. D) The auditor sues a client for not cooperating during the engagement.

Answer:  C

Terms:  Liability under federal securities acts

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

 

6) A CPA firm normally uses one or a combination of four defenses when there are legal claims by clients. Which one of the following is generally not a defense?

  1. A) lack of duty
  2. B) nonnegligent performance
  3. C) contributory negligence
  4. D) foreseeable users

Answer:  D

Terms:  Auditors’ defenses against lawsuits

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

 

 

7) Tort actions against CPAs are more common than breach of contract actions because

  1. A) there are more torts than contracts.
  2. B) the burden of proof is on the auditor rather than on the person suing.
  3. C) the person suing need prove only negligence.
  4. D) the amounts recoverable are normally larger.

Answer:  D

Terms:  Tort actions against CPAs

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

 

8) The principal issue to be resolved in cases involving alleged negligence is usually

  1. A) the amount of the damages suffered by plaintiff.
  2. B) whether to impose punitive damages on defendant.
  3. C) the level of care exercised by the CPA.
  4. D) whether defendant was involved in fraud.

Answer:  C

Terms:  Principal issue to be resolved in cases involving alleged negligence

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

9) In the auditing environment, failure to meet auditing standards is often

  1. A) an accepted practice.
  2. B) a suggestion of negligence.
  3. C) conclusive evidence of negligence.
  4. D) tantamount to criminal behavior.

Answer:  C

Terms:  Failure to meet auditing standards

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

 

10) A common way for a CPA firm to demonstrate a lack of duty to perform is by use of a(n)

  1. A) expert witness’ testimony.
  2. B) engagement letter.
  3. C) management representation letter.
  4. D) confirmation letter.

Answer:  B

Terms:  Common way to demonstrate lack of duty to perform

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

 

 

11) To succeed in an action against the auditor, the client must be able to show that

  1. A) the auditor was fraudulent.
  2. B) the auditor was grossly negligent.
  3. C) there was a written contract.
  4. D) there is a close causal connection between the auditor’s behavior and the damages suffered by the client.

Answer:  D

Terms:  Auditors’ defenses against lawsuits

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

 

12) Which of the following is a true statement regarding auditors’ liability?

  1. A) The level of care is easy to determine in a review or compilation.
  2. B) Engagement letters will relieve the auditor of all liability.
  3. C) An auditor will always be guilty of negligence if they fail to uncover fraud.
  4. D) The most common source of lawsuits against CPAs is from clients.

Answer:  D

Terms:  Auditors’ liability to clients

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

13) One of the changes in auditing procedures which was brought about as a result of the 1136 Tenants case was that auditors were encouraged to begin using

  1. A) letters of representation.
  2. B) confirmation letters.
  3. C) engagement letters.
  4. D) billet doux letters.

Answer:  C

Terms:  Audit procedure brought about by 1136 Tenants case

Diff:  Challenging

Objective:  LO 5-4

AACSB:  Reflective thinking

 

 

14) The King Surety Company wrote a general fidelity bond covering thefts of assets by the employees of Wilson, Inc. Thereafter, Cooney, an employee of Wilson, embezzled $17,200 of company funds. When the activities were discovered, King paid Wilson the full amount in accordance with the terms of the fidelity bond, and then sought recovery against Wilson’s auditors, Lynch & Merritt, CPAs. Which of the following would be Lynch & Merritt’s best defense?

  1. A) King is not in privity of contract.
  2. B) The shortages were the result of clever forgeries and collusive fraud which would not be detected by an examination made in accordance with generally accepted auditing standards.
  3. C) Lynch & Merritt were not guilty either of gross negligence or fraud.
  4. D) Lynch & Merritt were not aware of the King-Wilson surety relationship.

Answer:  B

Terms:  Defense in recovery against auditors with employee theft

Diff:  Challenging

Objective:  LO 5-4

AACSB:  Analytic thinking

 

15) There are four major sources of an auditor’s legal liability. One source is liability to the audit client. List the other three sources.

Answer:  The other three sources of auditor’s legal liability are:

  • liability to third parties under common law
  • civil liability under federal securities laws
  • criminal liability

Terms:  Sources of auditor’s legal liability

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

16) Discuss each of the four defenses a CPA firm can normally use when facing legal claims by clients.

Answer:

Lack of duty. The CPA firm claims that there was no implied or expressed contract.

 

Non-negligent performance. The CPA firm claims that the audit was performed in accordance with auditing standards.

 

Contributory negligence. The CPA firm claims that the client’s own actions resulted in the loss that is the basis for the damages, or interfered with the conduct of the audit in such a way that prevented that auditor from discovering the cause of the loss. This defense is not available in third-party suits.

 

Absence of causal connection. The CPA firm claims that the auditor’s failure to follow auditing standards did not cause the damages suffered by the client.

Terms:  Auditors’ defenses against lawsuits

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

 

17) An example of auditor legal liability to third parties under common law would be the federal government prosecuting an auditor for knowingly issuing an incorrect audit report.

Answer:  FALSE

Terms:  Four major sources of auditors’ legal liability

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

 

18) The 1136 Tenants case was a criminal case concerning a CPA’s failure to uncover fraud during a financial statement audit.

Answer:  FALSE

Terms:  1136 Tenants case

Diff:  Moderate

Objective:  LO 5-4

AACSB:  Reflective thinking

 

19) Many litigation experts believe that a well written engagement letter significantly reduces the likelihood of adverse legal actions.

Answer:  TRUE

Terms:  Reasons for an audit and audit evidence

Diff:  Easy

Objective:  LO 5-4

AACSB:  Reflective thinking

5.5   Learning Objective 5-5

 

1) A financial institution sues the audit firm for failure to discover that a borrower’s financial statements are materially misstated. This is an example of which of the following legal liability concepts?

  1. A) liability to clients
  2. B) liability to third parties under common law
  3. C) civil liability under federal securities law
  4. D) criminal liability

Answer:  B

Terms:  Liability to third parties under common law

Diff:  Easy

Objective:  LO 5-5

AACSB:  Reflective thinking

 

 

2) Which of the following auditor’s defenses usually means nonreliance on the financial statements by the user?

  1. A) lack of duty
  2. B) non negligent performance
  3. C) absence of causal connections
  4. D) contributory negligence

Answer:  C

Terms:  Auditor defenses against third party suits

Diff:  Easy

Objective:  LO 5-5

AACSB:  Analytic thinking

 

3) A group typically included as “third parties” in common law is

  1. A)
Actual and potential stockholders Employees of client
Yes Yes

 

  1. B)
Actual and potential stockholders Employees of client
No No

 

  1. C)
Actual and potential stockholders Employees of client
Yes No

 

  1. D)
Actual and potential stockholders Employees of client
No Yes

 

Answer:  A

Terms:  Third parties in common law

Diff:  Moderate

Objective:  LO 5-5

AACSB:  Reflective thinking

4) The major conclusion of the 1931 Ultramares case was that

  1. A) ordinary negligence is insufficient for liability to third parties.
  2. B) third parties must file criminal charges, not civil charges, against the auditor.
  3. C) fraud or gross negligence is sufficient for liability to third parties.
  4. D) auditors have no liabilities to third parties.

Answer:  A

Terms:  Major conclusion of 1931 Ultramares case

Diff:  Moderate

Objective:  LO 5-5

AACSB:  Reflective thinking

 

 

5) Under common law, a foreseen user would be treated the same as

  1. A)
A primary beneficiary A known third party
Yes Yes

 

  1. B)
A primary beneficiary A known third party
No No

 

  1. C)
A primary beneficiary A known third party
Yes No

 

  1. D)
A primary beneficiary A known third party
No Yes

 

Answer:  A

Terms:  Foreseen user under common law treated the same as

Diff:  Moderate

Objective:  LO 5-5

AACSB:  Reflective thinking

 

6) A broad interpretation of the rights of third-party beneficiaries holds that users the auditor should have been able to foresee as being likely users of financial statements have the same rights as those with privity of contract. This is known as the concept of

  1. A) foreseen users.
  2. B) foreseeable users.
  3. C) expected users.
  4. D) four-party contracts.

Answer:  B

Terms:  Rights of third-party beneficiaries; Privity of contract

Diff:  Moderate

Objective:  LO 5-5

AACSB:  Reflective thinking

7) Which of the auditor’s defenses is ordinarily not available when lawsuits are filed by a third party?

  1. A) absence of causal connections
  2. B) contributory negligence
  3. C) nonnegligent performance
  4. D) lack of duty

Answer:  B

Terms:  Auditor defenses against third party suits

Diff:  Moderate

Objective:  LO 5-5

AACSB:  Reflective thinking

 

8) According to the principle established by the Restatement of Torts, foreseen users must be members of

  1. A) any potential user group.
  2. B) a legally protected class.
  3. C) a reasonably limited and identifiable user group.
  4. D) a reasonably limited and established user group.

Answer:  C

Terms:  Principle established by Restatement of Torts

Diff:  Moderate

Objective:  LO 5-5

AACSB:  Reflective thinking

 

9) Under the Ultramares doctrine, ordinary negligence is insufficient for liability to third parties unless the third party is

  1. A) a primary beneficiary.
  2. B) an injured party.
  3. C) a foreseen user.
  4. D) a bank.

Answer:  A

Terms:  Ultramares doctrine

Diff:  Moderate

Objective:  LO 5-5

AACSB:  Reflective thinking

 

10) Under common law, an individual or company that (1) does not have a contract with an auditor, (2) is known by the auditor in advance of the audit, and (3) will use the auditor’s report to make decisions about the client company has:

  1. A) no rights unless an auditor is grossly negligent.
  2. B) no rights unless an auditor is fraudulent.
  3. C) no rights against an auditor.
  4. D) the same rights against an auditor as a client.

Answer:  D

Terms:  Common law third-party rights

Diff:  Challenging

Objective:  LO 5-5

AACSB:  Analytic thinking

 

11) The basic legal concept which was affirmed in the 1985 New York case, Credit Alliance, was that

  1. A) the auditor’s defense of privity of contract is still valid against third parties.
  2. B) the auditor is liable for ordinary negligence to specifically foreseen third parties.
  3. C) the auditor is liable for ordinary negligence to reasonably foreseeable third parties.
  4. D) the auditor’s defense of contributory negligence is no longer valid.

Answer:  A

Terms:  Basic legal concept affirmed in 1985 case, Credit Alliance

Diff:  Challenging

Objective:  LO 5-5

AACSB:  Analytic thinking

 

12) As a consequence of his failure to adhere to generally accepted auditing standards in the course of his examination of the Lamp Corp., Harrison, CPA, did not detect the embezzlement of a material amount of funds by the company’s controller. As a matter of common law, to what extent would Harrison be liable to the Lamp Corp. for losses attributable to the theft?

  1. A) He would have no liability, since the ordinary examination cannot be relied upon to detect thefts of assets by employees.
  2. B) He would have no liability because privity of contract is lacking.
  3. C) He would be liable for losses attributable to his negligence.
  4. D) He would be liable only if it could be proven that he was grossly negligent.

Answer:  C

Terms:  Under common law, extent of liability where auditor failed to adhere to generally accepted auditing standards in examination of client and failed to detect employee embezzlement

Diff:  Challenging

Objective:  LO 5-5

AACSB:  Analytic thinking

 

13) If an auditor is unsuccessful in using the lack of duty defense to have a case dismissed in a third-party suit, the preferred defense is

  1. A) lack of duty to perform.
  2. B) nonnegligent performance.
  3. C) absence of causal connection.
  4. D) client fraud.

Answer:  B

Terms:  Preferred defense in third-party suits

Diff:  Moderate

Objective:  LO 5-5

AACSB:  Reflective thinking

 

14) Three approaches to the application of the foreseen users’ concept are (1) the Credit Alliance approach, (2) the Restatement of Torts approach, and (3) the foreseeable user approach. Summarize each of these three approaches.

Answer:  The Credit Alliance approach upholds the concept of privity of contract established by the Ultramares Corporation v. Touche case. Under this approach, for an auditor to be liable to third parties, the auditor (1) must know and intend that the work product would be used by the third-party for a specific purpose, and (2) the knowledge and intent must be evidenced by the auditor’s conduct.

 

Under the Restatement of Torts approach, foreseen users must be members of a reasonably limited and identifiable group of users that have relied on the CPA’s work, such as creditors, even though those persons were not specifically known to the CPA at the time the work was done.

 

Under the foreseeable user approach, any users that the auditor should have reasonably been able to foresee as likely users of the client’s financial statements have the same rights as those with privity of contract.

Terms:  Three approaches to the application of foreseen users’ concepts

Diff:  Challenging

Objective:  LO 5-5

AACSB:  Reflective thinking

 

15) Although there is confusion caused by the differing views of liability to third parties under common law, the movement is clearly away from the foreseeable user approach.

Answer:  TRUE

Terms:  Foreseeable user approach

Diff:  Moderate

Objective:  LO 5-5

AACSB:  Reflective thinking

 

16) The broadest interpretation of the right of third-party beneficiaries is the primary user concept.

Answer:  FALSE

Terms:  Third-party liability under common law

Diff:  Challenging

Objective:  LO 5-5

AACSB:  Reflective thinking

 

17) The Credit Alliance approach to the concept of foreseen users states that to be liable to third parties, an auditor (1) must know and intend that the work product would be used by the third-party for a specific purpose, and (2) the knowledge and intent must be evidenced by the auditor’s conduct.

Answer:  TRUE

Terms:  Credit Alliance approach

Diff:  Challenging

Objective:  LO 5-5

AACSB:  Reflective thinking

 

5.6   Learning Objective 5-6

 

1) An adequate system of internal control for SEC registrants was originally required by the

  1. A) Sarbanes-Oxley Act of 2002.
  2. B) Securities Act of 1933.
  3. C) Foreign Corrupt Practices Act of 1977.
  4. D) Securities Act of 1934.

Answer:  C

Terms:  Required an adequate system of internal control for SEC registrants

Diff:  Easy

Objective:  LO 5-6

AACSB:  Reflective thinking

 

2) The increased litigation under the federal securities laws has resulted from

  1. A)
The availability of class-action litigation The strict liability standards imposed on CPAs by the securities laws An excess of attorneys
Yes Yes Yes

 

  1. B)
The availability of class-action litigation The strict liability standards imposed on CPAs by the securities laws An excess of attorneys
Yes No No

 

  1. C)
The availability of class-action litigation The strict liability standards imposed on CPAs by the securities laws An excess of attorneys
Yes Yes No

 

  1. D)
The availability of class-action litigation The strict liability standards imposed on CPAs by the securities laws An excess of attorneys
No No No

 

Answer:  C

Terms:  Increased litigation under federal securities law

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

 

3) Under the Securities Act of 1933, the auditor’s responsibility for making sure the financial statements were fairly stated extends to

  1. A) the date of the financial statements.
  2. B) the date the registration statement becomes effective.
  3. C) the date of the audit report.
  4. D) one year beyond the date of the financial statements.

Answer:  B

Terms:  Securities Act of 1933

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

4) Under the Securities Exchange Act of 1934, which type of organization is required to submit audited financial statements to the SEC?

  1. A) every company with securities traded on national and over-the-counter exchanges
  2. B) every corporation
  3. C) every company issuing new securities
  4. D) every corporation which is chartered by a state government

Answer:  A

Terms:  Securities Act of 1934; Organizations required to submit audited financial statements

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

5) The Securities and Exchange Commission can impose all but which of the following sanctions?

  1. A) suspend a CPA from auditing SEC clients
  2. B) prohibit a CPA from accepting new SEC clients for a period of time
  3. C) require a CPA to participate in continuing-education programs and make changes in their practice
  4. D) revoke a CPA license

Answer:  D

Terms:  Securities and Exchange Commission can impose sanctions

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

 

6) The Foreign Corrupt Practices Act (FCPA) of 1977

  1. A) requires auditors to review and evaluate systems of internal control as a part of an audit.
  2. B) requires SEC registrants to maintain a reasonably complete and accurate set of records and an adequate system of internal control.
  3. C) requires auditors to review client’s internal control system in a manner which is thorough enough to judge whether client meets the requirements of the FCPA.
  4. D) requires auditors to file a report with the SEC if client’s internal control system is inadequate.

Answer:  B

Terms:  Foreign Corrupt Practices Act of 1977

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

7) While the Foreign Corrupt Practices Act of 1977 remains in effect, its internal control provisions have been largely superseded by which of the following?

  1. A) Sarbanes-Oxley Act of 2002
  2. B) Racketeer Influenced and Corrupt Organization Act
  3. C) Federal False Statements Statute
  4. D) Federal Mail Fraud Statute

Answer:  A

Terms:  Foreign Corrupt Practices Act of 1977; Internal control provisions

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

Topic:  SOX

8) Which of the following is an accurate statement regarding recent actions brought against accountants by clients and third parties?

  1. A) Litigants will first seek state remedies because of the availability of class-action litigation.
  2. B) Gross negligence by the auditor must be proven under the Securities Acts of 1933 and 1934.
  3. C) The greatest growth in CPA liability litigation bas been under the federal securities laws.
  4. D) The amount of damages that plaintiffs can receive is greater under common law than under the federal securities laws.

Answer:  C

Terms:  Factor in increase in number of lawsuits and sizes of awards

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

 

9) A major purpose of federal securities regulations is to

  1. A) provide sufficient reliable information to the investing public who purchase securities in the marketplace.
  2. B) establish the qualifications for accountants who are members of the profession.
  3. C) eliminate incompetent attorneys and accountants who participate in the registration of securities to be offered to the public.
  4. D) provide a set of uniform standards and tests for accountants, attorneys, and others who practice before the Securities and Exchange Commission.

Answer:  A

Terms:  Major purpose of federal securities regulations

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

10) The 2012 news of a massive alleged bribery scheme involving Wal-Mart has brought charges against the company under the

  1. A) Securities Act of 1933.
  2. B) Securities Act of 1934.
  3. C) Foreign Corrupt Practices Act of 1977.
  4. D) Sarbanes-Oxley Act of 2002

Answer:  C

Terms:  Foreign Corrupt Practices Act of 1977

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

11) Which of the following statements about the Securities Act of 1933 is not true?

  1. A) A third party that purchased securities described in the registration statement may sue the auditor for material misrepresentations or omissions in the audited financial statements.
  2. B) A third party user does not have the burden of proof that he/she relied on the financial statements.
  3. C) A third party user has the burden of proof that the auditor was either negligent or fraudulent in doing the audit.
  4. D) A third party user does not have the burden of proof that the loss was caused by the misleading statements.

Answer:  C

Terms:  Securities Act of 1933

Diff:  Challenging

Objective:  LO 5-6

AACSB:  Analytic thinking

 

 

12) The most significant audit issue that came as a result of the court decision in the Escott et al. v. BarChris Construction Corporation case in 1968 was

  1. A) the court’s reaffirmation that the burden of proof was on the plaintiff to prove the auditor was negligent.
  2. B) the affirmation of an increase in the auditor’s responsibility when performing a review of events subsequent to the balance sheet date (S-1 review) for registration statements.
  3. C) the increased auditor responsibility when associated with unaudited financial statements.
  4. D) the court’s refusal to allow the percentage-of-completion method of accounting for revenues.

Answer:  B

Terms:  Significant audit issue from Escott et al v. BarChris Construction Corporation case

Diff:  Challenging

Objective:  LO 5-6

AACSB:  Reflective thinking

 

13) One significant result of the Escott et al. v. BarChris Construction Corporation case was

  1. A) a greater emphasis on subsequent events procedures.
  2. B) new standards for unaudited statements.
  3. C) a broader definition of third party beneficiaries.
  4. D) a requirement that more companies file annual reports with the SEC.

Answer:  A

Terms:  Significant result from Escott et al v. Bar Chris Construction Corporation case

Diff:  Challenging

Objective:  LO 5-6

AACSB:  Reflective thinking

 

14) Under the Securities Exchange Act of 1934, most of the litigation against the auditor has been generated because of the auditor’s involvement with the

  1. A) 8-K form.
  2. B) 10-K form.
  3. C) 10-Q form.
  4. D) S-1 form.

Answer:  B

Terms:  Securities Exchange Act of 1934

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

15) Section 10 and Rule 10b-5 of the Securities Exchange Act of 1934 are often referred to as

  1. A) the antifraud provisions.
  2. B) the new issues provisions.
  3. C) the full employment act for accountants.
  4. D) the RICO provisions.

Answer:  A

Terms:  Securities Exchange Act of 1934 Section 10 and Rule 10b-5

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

16) The U.S. Supreme Court ruled in 1976 in Hochfelder v. Ernst & Ernst that before CPAs could be held liable for Rule 10b-5 of the Securities Exchange Act of 1934, the auditor’s ________ would be required to be shown to the court.

  1. A) ordinary negligence
  2. B) gross negligence
  3. C) knowledge and intent to deceive
  4. D) financial gain at the expense of the plaintiff

Answer:  C

Terms:  Securities Exchange Act of 1934 Rule 10b-5; U.S. Supreme Court ruled in 1976 in Hochfelder v. Ernst & Ernst

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

17) Under the Securities Act of 1933,

  1. A) any party who relies on the company’s audited financial statements can recover from the auditors.
  2. B) third-party users must prove that the auditor was negligent.
  3. C) the burden of proof is on the defendant.
  4. D) auditors face potential legal exposure for information contained in the Form 10-Q.

Answer:  C

Terms:  Securities and Exchange Commission

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

18) Which of the following is an accurate statement regarding Rule 10b-5 of the Securities Exchange Act of 1934?

  1. A) The Supreme Court has ruled that liability under Rule 10b-5 does not extend to aiders or abettors who participated in financial statement misstatements that were not the primary defendants.
  2. B) Federal court decisions have clarified that Rule 10b-5 applies only to direct sellers.
  3. C) Hochfelder and subsequent court decisions have increased the liability of auditors under Rule 10b-5.
  4. D) According to most recent court decisions, poor judgment is proof of fraud.

Answer:  A

Terms:  Securities Exchange Act of 1934 Section 10 and Rule 10b-5

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Analytic thinking

 

19) Discuss the sanctions the Securities and Exchange Commission can impose on auditors.

Answer:  The SEC has the power in certain circumstances to sanction or suspend practitioners from doing audits for SEC companies. The SEC’s Rules of Practice permit them to temporarily or permanently deny a CPA or CPA firm from being associated with financial statements of public companies, either because of lack of appropriate qualifications or having engaged in unethical or improper professional conduct.

 

In recent years, the SEC has temporarily suspended a number of individual CPAs from doing any audits of SEC clients. It has also prohibited a number of CPA firms from accepting any new SEC clients for a period. In some cases, the SEC has required an extensive review of a major CPA firm’s practices by another CPA firm, or made CPA firms make changes in their practices. Individual CPAs and their firms have also been required to participate in continuing education programs. Sanctions such as these are published by the SEC and are often reported in the business press, making them a significant embarrassment to those involved.

Terms:  Securities Exchange Act of 1934 Section 10 and Rule 10b-5

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

20) One result from the Escott et al. v. BarChris case was a greater emphasis being placed on the audit staff’s understanding of the client’s business and industry.

Answer:  TRUE

Terms:  Escott et al. v. BarChris

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

21) The only parties who can recover from auditors under the Securities Act of 1933 are original purchasers of securities.

Answer:  TRUE

Terms:  Securities Act of 1933

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

22) Under the Securities Act of 1933, a third party plaintiff does not have the burden of proof that he or she relied on the financial statements or that the auditor was negligent or fraudulent in doing the audit. Rather, the plaintiff need only prove that the audited financial statements contained a material misrepresentation or omission.

Answer:  TRUE

Terms:  Securities Act of 1933; Burden of proof

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

23) Companies with securities traded on national and over-the-counter exchanges are required to submit audited financial statements once every three years to the Securities and Exchange Commission.

Answer:  FALSE

Terms:  Securities Act Commission; Securities traded on national exchanges

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

24) The same three defenses available to auditors in common lawsuits by third parties—nonnegligent performance, lack of duty, and absence of causal connection—are also available for suits under the Securities Exchange Act of 1934.

Answer:  TRUE

Terms:  Securities Act of 1934; Defenses available to auditors in common law suits by third parties

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

25) The defense of contributory negligence by a third party is often used by auditors if charged with a violation of the 1934 Securities Act.

Answer:  FALSE

Terms:  Securities Exchange Act of 1934

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

26) The Sarbanes-Oxley Act requires the CEO and CFO of a public company to certify the annual and quarterly financial statements filed with the PCAOB.

Answer:  FALSE

Terms:  Sarbanes-Oxley Act

Diff:  Moderate

Objective:  LO 5-6

AACSB:  Reflective thinking

 

 

5.7   Learning Objective 5-7

 

1) In which case were auditors prosecuted for filing false financial statements for a client with the government?

  1. A) United States v. Natelli
  2. B) United States v. Simon
  3. C) Escott et al. v. BarChris
  4. D) ESM Government Securities v. Alexander Grant & Co.

Answer:  B

Terms:  Case where auditors were prosecuted for filing false financial statements

Diff:  Moderate

Objective:  LO 5-7

AACSB:  Reflective thinking

2) A CPA is subject to criminal liability if the CPA

  1. A) refuses to turn over requested audit documentation to a client.
  2. B) performs an audit in a negligent manner.
  3. C) is knowingly involved with false financial statements.
  4. D) willfully breaches a contract with a client.

Answer:  C

Terms:  CPA subject to criminal liability

Diff:  Moderate

Objective:  LO 5-7

AACSB:  Reflective thinking

 

3) Critical lessons learned after analyzing major criminal cases against auditors include the fact that

  1. A) the partner, but not the audit staff, must be independent.
  2. B) transactions with related parties are an indication of fraud.
  3. C) an investigation of the integrity of management is an important part of deciding whether to accept a new client.
  4. D) accounting principles can be relied on exclusively in deciding if the financial statements are fairly presented.

Answer:  C

Terms:  CPAs held liable for criminal activity and federal laws; Infamous cases

Diff:  Moderate

Objective:  LO 5-7

AACSB:  Reflective thinking

 

 

4) The Sarbanes-Oxley Act of 2002 makes it a felony to destroy or create documents to impede or obstruct a federal investigation. Those provisions were adopted following which of the following legal cases?

  1. A) United States v. Natelli
  2. B) United States v. Andersen
  3. C) ESM Government Securities v. Alexander Grant & Co.
  4. D) United States v. Simon

Answer:  B

Terms:  CPAs held liable for criminal activity and federal laws; Infamous cases

Diff:  Moderate

Objective:  LO 5-7

AACSB:  Analytic thinking

5) CPAs can be held liable for criminal activity under both state and federal laws. Infamous cases include United States vs. Natelli and ESM Government Securities v. Alexander Grant and Co. Discuss what occurred in each case.

Answer:  Natelli–two auditors were convicted of criminal liability under the 1934 act for certifying financial statements of National Student Marketing Corporation that contained inadequate disclosures.

 

ESM–management revealed to the partner in charge of the audit of ESM that the previous year’s financial statements contained a material misstatement. Rather than complying with the profession and firm standards, the partner agreed to say nothing in the hope that management would work its way out of the problem during the current year. The partner was convicted of criminal charges for his role in sustaining the fraud.

Terms:  CPAs held liable for criminal activity and federal laws; Infamous cases

Diff:  Moderate

Objective:  LO 5-7

AACSB:  Reflective thinking

 

6) The Sarbanes-Oxley Act of 2002 makes destruction of audit documentation punishable by up to 10 years in prison.

Answer:  FALSE

Terms:  Sarbanes-Oxley Act of 2002; Destruction of audit documentation punishable

Diff:  Challenging

Objective:  LO 5-7

AACSB:  Reflective thinking

Topic:  SOX

 

 

5.8   Learning Objective 5-8

 

1) Which of the following resulted in a federal law passed in 1995 that significantly reduced potential damages in securities-related litigation?

  1. A) Private Securities Litigation Reform Act
  2. B) Public Securities Damages and Settlements Act
  3. C) Racketeer Influenced and Corrupt Organization Act
  4. D) U.S. Securities Claims Reform Act

Answer:  A

Terms:  Federal law passed in 1995 significantly reduced potential damages

Diff:  Moderate

Objective:  LO 5-8

AACSB:  Reflective thinking

 

2) In order to protect themselves from legal liability, it is important that CPAs

  1. A) are organized as sole-proprietors.
  2. B) accept client representations.
  3. C) understand the client’s business.
  4. D) use engagement letters, not representation letters.

Answer:  C

Terms:  Protecting individual CPAs from legal liability

Diff:  Moderate

Objective:  LO 5-8

AACSB:  Reflective thinking

3) Discuss at least 3 steps the AICPA and the accounting profession as a whole can and are taking to reduce the practitioner’s exposure to lawsuits.

Answer:  Steps the profession is taking to reduce practitioners’ exposure to lawsuits include:

  • Set standards and revise them to meet the changing needs of auditing.
  • Oppose lawsuits.
  • Educate investors and other users of financial statements as to the meaning of an auditor’s opinion and the extent and nature of the auditor’s work.
  • Sanction members for improper conduct and performance.
  • Lobby for changes in laws.

Terms:  Steps the AICPA and accounting profession taking to reduce practitioner’s exposure to lawsuits

Diff:  Moderate

Objective:  LO 5-8

AACSB:  Reflective thinking

 

4) Match eight of the following terms (a-n) with the definitions provided below (1-8):

 

  1. Foreign Corrupt Practices Act
  2. Securities Exchange Act of 1934
  3. Securities Litigation Uniform Standards Act of 1998
  4. Securities Act of 1933
  5. Ultramares doctrine
  6. audit risk
  7. audit failure
  8. standards failure
  9. business failure
  10. absence of causal connection
  11. contributory negligence
  12. lack of duty to perform
  13. nonnegligent performance

 

________ 1. a situation in which an incorrect audit opinion is issued because it failed to comply with the requirements of auditing standards

 

________ 2. a federal statute dealing with companies that trade securities on national and over-the-counter exchanges. Auditors are involved because the annual reporting requirements include audited financial statements.

 

________ 3. an auditor’s legal defense under which the auditor claims that the client’s own actions either resulted in the loss that is the basis for damages or interfered with the conduct of the audit in such a way that prevented the auditor from discovering the cause of the loss

 

________ 4. a federal statute that makes it illegal to offer a bribe to an official of a foreign country

 

________ 5. a common-law approach to third-party liability in which ordinary negligence is insufficient for liability to third parties, because of the lack of privity of contract between the third-party and the auditor unless the third-party is a primary beneficiary

 

________ 6. a federal statute designed to significantly reduce the potential damages in federal securities-related litigation by providing for proportionate liability in most cases

 

________ 7. an auditor’s legal defense under which the auditor claims that the audit was performed in accordance with generally accepted auditing standards

 

________ 8. an auditor’s legal defense under which the auditor claims that the failure to follow auditing standards did not cause the damages suffered by the client

Answer:  1. g, 2. b, 3. k, 4. a, 5. e, 6. c, 7. m, 8. j

Terms:  Audit failure; Securities Exchange Act of 1934; Contributory negligence; Foreign Corrupt Practices Act; Securities Litigation Uniform Standards Act of 1998; Ultramares doctrine; Nonnegligent performance; Absence of causal connection

Diff:  Moderate

Objective:  LO 5-8

AACSB:  Reflective thinking

 

5) Discuss some of the steps practicing auditors can take to minimize their legal liability.

Answer:  There are many steps individual practitioners can take to minimize legal liability including:

  • Deal only with clients possessing integrity
  • Maintain independence
  • Understand the client’s business
  • Perform quality audits
  • Document the work properly
  • Obtain an engagement letter and a representation letter
  • Exercise professional skepticism
  • Carry adequate insurance
  • Choose a form of organization that provides some form of legal liability protection to owners
  • Consult with experienced legal counsel in the event of actual or threatened litigation

Terms:  Steps auditors can take to minimize legal liability

Diff:  Easy

Objective:  LO 5-8

AACSB:  Reflective thinking

 

6) The Private Securities Litigation Reform Act of 1995 capped damage awards against auditors to the amount of the audit fees charged.

Answer:  FALSE

Terms:  Private Securities Litigation Reform Act of 1995

Diff:  Easy

Objective:  LO 5-8

AACSB:  Reflective thinking

 

Auditing and Assurance Services, 16e (Arens/Elder/Beasley)

Chapter 15   Audit Sampling for Tests of Controls and Substantive Tests of Transactions

 

15.1   Learning Objective 15-1

 

1) A sample in which the characteristics of the sample are the same as those of the population is a(n)

  1. A) variables sample.
  2. B) representative sample.
  3. C) attributes sample.
  4. D) random sample.

Answer:  B

Terms:  Sample in which characteristics of sample are same as population

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

2) When the auditor decides to select less than 100 percent of the population for testing, the auditor is said to use

  1. A) audit sampling.
  2. B) representative sampling.
  3. C) poor judgment.
  4. D) estimation sampling.

Answer:  A

Terms:  Auditor selects less than 100 percent of population for testing

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

3) To determine if a sample is truly representative of the population, an auditor would be required to

  1. A) conduct multiple samples of the same population.
  2. B) never use sampling because of the expense involved.
  3. C) audit the entire population.
  4. D) use systematic sample selection.

Answer:  C

Terms:  Sample truly representative of population

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

 

4) One of the causes of nonsampling risk is

  1. A) choosing the wrong sample size.
  2. B) ineffective audit procedures.
  3. C) inadequate sample size.
  4. D) exceptions being found in the sample.

Answer:  B

Terms:  Nonsampling risk

Diff:  Moderate

Objective:  LO 15-1

AACSB:  Reflective thinking

5) Which one of the choices below is most correct regarding a cause of sampling risk?

  1. A) ineffective use of audit procedures
  2. B) testing less than the entire population
  3. C) use of extensive tests of controls
  4. D) use of random sampling

Answer:  B

Terms:  Sampling risk

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

6) An auditor can increase the likelihood that a sample is representative by using care in

  1. A)
Designing the sampling process Designing the sample selection
Yes Yes

 

  1. B)
Designing the sampling process Designing the sample selection
No No

 

  1. C)
Designing the sampling process Designing the sample selection
Yes No

 

  1. D)
Designing the sampling process Designing the sample selection
No Yes

 

Answer:  A

Terms:  Increased likelihood that sample is representative

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

 

7) Which of the following is the risk that audit tests will not uncover existing exceptions in a sample?

  1. A) sampling risk
  2. B) nonsampling risk
  3. C) audit risk
  4. D) detection risk

Answer:  B

Terms:  Risk that audit tests will not uncover existing exceptions

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

8) Which of the following is the risk that an auditor will reach an incorrect conclusion because a sample is not representative of the population?

  1. A) sampling risk
  2. B) nonsampling risk
  3. C) audit risk
  4. D) detection risk

Answer:  A

Terms:  Risk auditor will reach an incorrect conclusion

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

 

9) Sampling risk may be controlled by

  1. A)
Adjusting the sample size Using an appropriate method of selecting sample items
Yes Yes

 

  1. B)
Adjusting the sample size Using an appropriate method of selecting sample items
No No

 

  1. C)
Adjusting the sample size Using an appropriate method of selecting sample items
Yes No

 

  1. D)
Adjusting the sample size Using an appropriate method of selecting sample items
No Yes

 

Answer:  A

Terms:  Sampling risk controlled by

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

10) Which of the following statements is most correct?

  1. A) A sample of all items of a population will eliminate sampling risk, but increase nonsampling risk.
  2. B) The use of an appropriate sample selection technique ensures a representative sample.
  3. C) The auditor’s failure to recognize an exception is a significant cause of sampling risk.
  4. D) The use of inappropriate audit procedures is a significant cause of nonsampling risk.

Answer:  D

Terms:  Sample selection; Sampling and nonsampling risk

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

11) Discuss what is meant by “sampling risk” and “nonsampling risk.”

Answer:  Sampling risk is the risk that an auditor reaches an incorrect conclusion because the sample is not representative of the population. Sampling risk is an inherent part of sampling that results from testing less than the entire population.

 

Nonsampling risk is the risk that the auditor reaches an incorrect conclusion for any reason not related to the sampling risk. The two causes of nonsampling risk are the auditor’s failure to recognize exceptions and inappropriate or ineffective audit procedures.

Terms:  Sampling and nonsampling risks

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

12) List the two ways auditors can control sampling risk.

Answer:  Auditors can control sampling risk by:

  1. adjusting the sample size.
  2. using an appropriate method of selecting sample items from the population.

Terms:  Sampling risk controlled by

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

13) Discuss two causes of nonsampling risk. Also discuss ways the auditor can control nonsampling risk.

Answer:  The two causes of nonsampling risk are (1) the auditor’s failure to recognize exceptions and (2) inappropriate or ineffective audit procedures. Careful design of audit procedures, proper instruction, supervision, and review are ways to control nonsampling risk.

Terms:  Nonsampling risk

Diff:  Moderate

Objective:  LO 15-1

AACSB:  Reflective thinking

 

14) Sampling risk results from the auditor’s failure to recognize exceptions in transaction data.

Answer:  FALSE

Terms:  Sampling risk

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

15) If an auditor does a test in the wrong direction, sampling risk will increase.

Answer:  FALSE

Terms:  Nonsampling risk

Diff:  Easy

Objective:  LO 15-1

AACSB:  Reflective thinking

 

16) If a particular internal control is not followed by the client exactly 6% of the time, and the auditor’s tests of that control find three control violations in a sample of 50, the sample is considered to be representative.

Answer:  TRUE

Terms:  Sample considered to be representative

Diff:  Moderate

Objective:  LO 15-1

AACSB:  Reflective thinking

 

17) In practice, auditors do not know whether a sample is representative, even after all testing is complete.

Answer:  TRUE

Terms:  Representative sample

Diff:  Moderate

Objective:  LO 15-1

AACSB:  Reflective thinking

 

18) One way to control sampling risk is to increase sample size.

Answer:  TRUE

Terms:  Control sampling risk is with sample size

Diff:  Moderate

Objective:  LO 15-1

AACSB:  Reflective thinking

 

19) A sample of all items in a population will have a zero sampling risk.

Answer:  TRUE

Terms:  Sample of all items in a population will have zero sampling risk

Diff:  Moderate

Objective:  LO 15-1

AACSB:  Reflective thinking

 

20) It is virtually impossible to reduce sampling risk to zero.

Answer:  TRUE

Terms:  Sampling risk

Diff:  Moderate

Objective:  LO 15-1

AACSB:  Reflective thinking

 

 

15.2   Learning Objective 15-2

 

1) There are three phases in both statistical and nonstatistical sampling. The first phase is to

  1. A) generate random numbers for the sample.
  2. B) evaluate the results.
  3. C) plan the sample.
  4. D) select the sample.

Answer:  C

Terms:  Statistical and nonstatistical sampling

Diff:  Easy

Objective:  LO 15-2

AACSB:  Reflective thinking

2) Which of the following statements is most correct with concerning the quantification of sampling risk?

  1. A) Sampling risk cannot be quantified.
  2. B) Sampling risk can be quantified only when nonprobabilistic selection techniques are used to select the sample.
  3. C) Sampling risk can be quantified only when probabilistic selection techniques are used to select the sample.
  4. D) None of the above is correct.

Answer:  C

Terms:  Quantification of sampling risk

Diff:  Easy

Objective:  LO 15-2

AACSB:  Reflective thinking

 

3) Which of the following statements is most correct with respect to the evaluation of nonprobabilistic sample results?

  1. A) It is acceptable to make nonprobabilistic evaluations only when probabilistic sample selection is used.
  2. B) It is acceptable to make nonprobabilistic evaluations only if the auditor cannot quantify sampling risk.
  3. C) It is never acceptable to evaluate a nonprobabilistic sample using statistical methods.
  4. D) All of the above are correct.

Answer:  C

Terms:  Evaluation of nonprobabilistic sample results

Diff:  Moderate

Objective:  LO 15-2

AACSB:  Reflective thinking

 

 

4) Which of the following is not a phase in the planning of both statistical and nonstatistical sampling?

  1. A) Plan the sample.
  2. B) Determine the probability that fraud has occurred.
  3. C) Select the sample and perform the tests.
  4. D) Evaluate the results.

Answer:  B

Terms:  Statistical and nonstatistical sampling

Diff:  Moderate

Objective:  LO 15-2

AACSB:  Reflective thinking

 

5) Which of the following statements is not correct regarding probabilistic and nonprobabilistic sample selection?

  1. A) In probabilistic selection, every population item has a known chance of being selected.
  2. B) It is acceptable to evaluate a nonprobabilistic sample using statistical methods.
  3. C) Probabilistic selection is required for all statistical sampling methods.
  4. D) Both probabilistic and nonprobabilistic methods are acceptable and commonly used.

Answer:  B

Terms:  Probabilistic and nonprobabilistic sample selection

Diff:  Challenging

Objective:  LO 15-2

AACSB:  Reflective thinking

6) Which of the following is a correct statement regarding probabilistic versus nonprobabilistic sample selection?

  1. A) Auditors may make nonstatistical evaluations when using probabilistic sample selection.
  2. B) The AICPA recommends probabilistic sample selection.
  3. C) Nonstatistical sampling can’t provide results that are as effective as a statistical sample.
  4. D) There is only one type of nonprobabilistic sample selection method.

Answer:  A

Terms:  Probabilistic and nonprobabilistic sample selection

Diff:  Moderate

Objective:  LO 15-2

AACSB:  Reflective thinking

 

7) An advantage of using statistical sampling techniques is that such techniques

  1. A) quantify sampling risk.
  2. B) eliminate the need for judgmental decisions.
  3. C) define the values of precision and reliability required to provide audit satisfaction.
  4. D) have been established in the courts to be superior to judgmental sampling.

Answer:  A

Terms:  Advantage of using statistical sampling techniques

Diff:  Challenging

Objective:  LO 15-2

AACSB:  Reflective thinking

 

8) Auditors who prefer statistical to nonstatistical sampling believe that the principal advantage of statistical sampling flows from its ability to

  1. A) quantify sampling risk.
  2. B) promote a more legally defensible procedural approach.
  3. C) define the precision required to provide audit satisfaction.
  4. D) establish conclusive audit evidence with decreased audit effort.

Answer:  A

Terms:  Advantage of statistical sampling over nonstatistical sampling

Diff:  Challenging

Objective:  LO 15-2

AACSB:  Reflective thinking

 

9) Which of the following is an accurate statement regarding sampling?

  1. A) A 95 percent confidence level provides a 5 percent sampling risk.
  2. B) The auditor can perform the audit tests only after the sample items are selected.
  3. C) The purpose of planning the sample is to make sure that the audit tests are performed in a manner that provides the desired sampling risk and minimizes the likelihood of nonsampling errors.
  4. D) All of the above are accurate statements.

Answer:  D

Terms:  Statistical and nonstatistical sampling

Diff:  Easy

Objective:  LO 15-2

AACSB:  Reflective thinking

10) Describe the differences between statistical and nonstatistical sampling in terms of (1) the sample selection methods used, and (2) quantification of sampling risk.

Answer:  Nonstatistical sampling differs from statistical sampling in that nonprobabilistic sampling can be used for nonstatistical sampling, but not for statistical sampling. In addition, sampling risk can be quantified when using statistical sampling but not when using nonstatistical sampling.

Terms:  Differences between statistical and nonstatistical sampling applying sample selection methods and quantification of sampling risk

Diff:  Moderate

Objective:  LO 15-2

AACSB:  Reflective thinking

 

11) List the three phases in audit sampling for both statistical and nonstatistical sampling.

Answer:

  • Plan the sample.
  • Select the sample and perform the tests.
  • Evaluate the results.

Terms:  Statistical and nonstatistical sampling

Diff:  Moderate

Objective:  LO 15-2

AACSB:  Reflective thinking

 

12) It is equally acceptable under professional auditing standards for auditors to use either statistical or nonstatistical sampling methods.

Answer:  TRUE

Terms:  Equally acceptable to use statistical or nonstatistical sampling methods

Diff:  Moderate

Objective:  LO 15-2

AACSB:  Reflective thinking

 

13) When using nonstatistical sampling, the sample must be a probabilistic one.

Answer:  FALSE

Terms:  Nonstatistical sampling; sample must be probabilistic

Diff:  Moderate

Objective:  LO 15-2

AACSB:  Reflective thinking

 

15.3   Learning Objective 15-3

 

1) A sample in which every possible combination of items in the population has an equal chance of constituting the sample is a

  1. A) random sample.
  2. B) statistical sample.
  3. C) judgment sample.
  4. D) representative sample.

Answer:  A

Terms:  Sample in which every possible combination has equal chance of constituting sample

Diff:  Easy

Objective:  LO 15-3

AACSB:  Reflective thinking

2) The process which requires the calculation of an interval and then selects the items based on the size of the interval is

  1. A) statistical sampling.
  2. B) random sample selection.
  3. C) systematic sample selection.
  4. D) computerized sample selection.

Answer:  C

Terms:  Process which requires calculation of an interval

Diff:  Easy

Objective:  LO 15-3

AACSB:  Reflective thinking

 

 

3) In systematic sample selection, the population size is divided by the number of sample items desired in order to determine the

  1. A) sampling interval.
  2. B) tolerable exception rate.
  3. C) computed upper exceptions rate.
  4. D) mean.

Answer:  A

Terms:  Systematic sample selection

Diff:  Easy

Objective:  LO 15-3

AACSB:  Reflective thinking

 

4) Which of the following methods of sample selection is appropriately used when selecting a random sample?

  1. A)
Auditor’s judgmental

selection of items

Use of random number generators Generalized audit software
Yes No Yes

 

  1. B)
Auditor’s judgmental

selection of items

Use of random number generators Generalized audit software
No Yes Yes

 

  1. C)
Auditor’s judgmental

selection of items

Use of random number generators Generalized audit software
Yes No No

 

  1. D)
Auditor’s judgmental

selection of items

Use of random number generators Generalized audit software
No Yes No

 

Answer:  B

Terms:  Methods of sample selection in selecting a random sample

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

5) Simple random sampling

  1. A) is used when there is a need to emphasize one or more types of population items.
  2. B) requires both input and output parameters to be set when using a random number generator.
  3. C) is generally used with replacement sampling.
  4. D) is a probabilistic sampling method.

Answer:  D

Terms:  Random sampling

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

6) When a population is divided into subpopulations, usually by dollar size, and larger samples are taken from the subpopulation with the larger sizes, ________ is being used.

  1. A) sampling with probability proportional to size
  2. B) stratified sampling
  3. C) block sampling
  4. D) haphazard sampling

Answer:  B

Terms:  Probabilistic sample selection methods

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

7) The advantage of systematic sample selection is that

  1. A) it is easy to use.
  2. B) there is limited possibility of it being biased.
  3. C) it is unnecessary to determine if the population is arranged randomly.
  4. D) it automatically selects items material to the financial statements.

Answer:  A

Terms:  Advantage of systematic sample selection

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

8) In performing a review of a client’s cash disbursements, an auditor uses systematic sample selection with a random start. The primary disadvantage of this technique is population items

  1. A) may occur twice in the sample.
  2. B) must be reordered in a systematic pattern before the sample can be drawn.
  3. C) may occur in a systematic pattern, thus negating the randomness of the sample.
  4. D) must be replaced in the population after sampling to permit valid statistical inference.

Answer:  C

Terms:  Disadvantage of systematic sample selection with random start

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

9) Which of the following is a correct statement regarding block sampling?

  1. A) It is acceptable to use block sampling only if a reasonable number of blocks are used.
  2. B) Block sampling uses sampling with replacement.
  3. C) Block sampling is a probabilistic sampling method.
  4. D) There is considerable cost and time involved when block sampling is used.

Answer:  A

Terms:  Block sampling

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

10) The most serious shortcoming of the haphazard sample selection method is

  1. A) it is not subject to statistical sampling methods.
  2. B) it is time consuming to use.
  3. C) it is costly to use.
  4. D) it is difficult to remain completely unbiased in the selection.

Answer:  D

Terms:  Haphazard sample selection

Diff:  Easy

Objective:  LO 15-3

AACSB:  Reflective thinking

 

11) Which of the following statements regarding block sampling is least likely to be true?

  1. A) Block sampling is the selection of several items in sequence.
  2. B) It is acceptable to use block sampling for tests of transactions only if a reasonable number of blocks is used.
  3. C) Only one block should be selected to increase the probability of a representative sample.
  4. D) Once the first item in the block is selected, the remainder of the block is chosen automatically.

Answer:  C

Terms:  Block sampling

Diff:  Challenging

Objective:  LO 15-3

AACSB:  Reflective thinking

 

12) When the auditor goes through a population and selects items using nonprobabilistic selection methods, without regard to their size, source, or other distinguishing characteristics, it is called

  1. A) block sample selection.
  2. B) haphazard selection.
  3. C) systematic sample selection.
  4. D) statistical selection.

Answer:  B

Terms:  Nonprobabilistic selection methods

Diff:  Easy

Objective:  LO 15-3

AACSB:  Reflective thinking

 

13) When auditors wish to evaluate a sample statistically, an acceptable selection method is:

  1. A) systematic sample selection.
  2. B) judgmental selection.
  3. C) haphazard selection.
  4. D) block sample selection.

Answer:  A

Terms:  Sample statistically

Diff:  Easy

Objective:  LO 15-3

AACSB:  Reflective thinking

 

14) Which is not a method used by auditors to generate random numbers?

  1. A) electronic spreadsheets
  2. B) systematic sample generators
  3. C) random number generators
  4. D) generalized audit software

Answer:  B

Terms:  Random sampling

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

15) What is the key advantage and disadvantage associated with systematic sample selection? How must auditors address this disadvantage?

Answer:  The key advantage is its ease of use. In most populations, a systematic sample can be drawn quickly and the approach automatically puts the numbers in sequence, making it easy to develop the appropriate documentation.

 

The key disadvantage is the possibility for bias. Because of the way systematic selection is done, once the first item in the sample is selected, all other items are chosen automatically. This causes no problem if the characteristic of interest is distributed randomly throughout the population, but this may not always be the case. Therefore, when auditors use systematic selection, they must consider possible patterns in the population data that can cause sample bias.

Terms:  Systematic sample selection

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

16) Describe each of the four types of sample selection methods commonly associated with statistical audit sampling.

Answer:  Four types of sample selection methods commonly associated with statistical audit sampling are:

  • Simple random sample selection. Every possible combination of elements in the population has an equal chance of being included in the sample.
  • Systematic sample selection. A probabilistic method of sampling in which the auditor calculates an interval (the population size divided by the number of sample items desired) and selects the items for the sample based on the size of the interval and a randomly selected number between zero and the interval size.
  • Probability proportional to size sample selection. The probability of selecting any individual population item is proportional to its recorded amount.
  • Stratified sample selection. A probabilistic method of sampling in which the population is divided into subpopulations, and samples are taken from each of the subpopulations.

Terms:  Types of sample selection methods associated with statistical audit sampling

Diff:  Challenging

Objective:  LO 15-3

AACSB:  Reflective thinking

 

17) When selecting a sample, random numbers may be obtained either with replacement or without replacement. Although both selection methods are theoretically sound, auditors rarely use replacement sampling.

Answer:  TRUE

Terms:  Selecting same with random numbers

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

18) Although systematic sample selection is easy to use, its primary disadvantage is that it is not a probabilistic sampling method.

Answer:  FALSE

Terms:  Systematic sample selection; probabilistic sampling method

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

19) Nonprobabilistic sampling methods are not based on mathematical probabilities, and therefore the representativeness of the sample may be difficult to determine.

Answer:  TRUE

Terms:  Nonprobabilistic selection methods

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

 

20) The use of haphazard sample selection is encouraged under professional auditing standards.

Answer:  FALSE

Terms:  Haphazard sample selection

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

21) Directed sample selection, block sample selection, and haphazard sample selection are three types of probabilistic sample selection methods.

Answer:  FALSE

Terms:  Probabilistic sample selections; Directed sample selection, block sample selection and haphazard selections

Diff:  Moderate

Objective:  LO 15-3

AACSB:  Reflective thinking

 

15.4   Learning Objective 15-4

 

1) Which of the following occurrences would be least likely to warrant further audit attention for the auditor?

  1. A) deviations from client’s established control procedures
  2. B) deviations from client’s budgeted values
  3. C) monetary misstatements in populations of transaction data
  4. D) monetary misstatements in populations of account balance details

Answer:  B

Terms:  Warrant further audit attention for auditor

Diff:  Easy

Objective:  LO 15-4

AACSB:  Reflective thinking

 

2) Which of the following statements is correct when dealing with sampling for exception rates?

  1. A) The term exception refers to both deviations from the client’s control procedures and amounts that are not monetarily correct.
  2. B) When used with sampling, the term deviation is synonymous with the term
  3. C) The actual population exception rate is the same as the sample exception rate.
  4. D) In using audit sampling for exception rates, the auditor is most concerned with the confidence interval.

Answer:  A

Terms:  Sample exception rate

Diff:  Moderate

Objective:  LO 15-4

AACSB:  Reflective thinking

 

 

3) In using audit sampling for exception rates

  1. A) the auditor wants to know the most the exception rate is likely to be.
  2. B) sampling error is the likelihood that the auditor will miss a monetary misstatement.
  3. C) the upper limit of the interval estimate is known as the sampling risk.
  4. D) the computed upper exception rate (CUER) cannot be considered in the context of specific audit objectives.

Answer:  A

Terms:  Sample exception rate

Diff:  Moderate

Objective:  LO 15-4

AACSB:  Reflective thinking

4) Which of the following is most correct when using audit sampling for exception rates?

  1. A) The auditor is concerned with the lowest rate.
  2. B) The auditor is concerned with the highest rate.
  3. C) The auditor is concerned with the average on previous audits.
  4. D) The auditor is not concerned with the exception rate for audits of nonpublic companies.

Answer:  B

Terms:  Auditing sampling for exception rates

Diff:  Moderate

Objective:  LO 15-4

AACSB:  Reflective thinking

 

5) The upper limit of the probable population exception rate is the

  1. A) upper exception rate.
  2. B) estimated population exception rate.
  3. C) computed upper exception rate.
  4. D) the tolerable exception rate.

Answer:  C

Terms:  Highest estimated exception rate in population

Diff:  Moderate

Objective:  LO 15-4

AACSB:  Reflective thinking

 

6) You are determining the significance of the following: you set a 5% risk of assessing control risk too low and your computation of the upper deviation risk is 7%. What could you conclude?

  1. A) There is a 95% chance the deviation rate is the population is less than 5%.
  2. B) There is a 5% chance the deviation rate in the population is less than 7%.
  3. C) There is a 95% chance the deviation rate in the population exceeds 95%.
  4. D) There is a 5% chance the deviation rate in the population exceeds 7%.

Answer:  D

Terms:  Risk of assessing control risk low and computation of upper deviation risk

Diff:  Challenging

Objective:  LO 15-4

AACSB:  Reflective thinking

 

 

7) What types of exceptions are auditors most concerned with when evaluating populations of accounting data?

Answer:  There are three types of exceptions that auditors are generally concerned with when evaluating populations of accounting data. They are:

  1. deviations from client’s established controls.
  2. monetary misstatements in populations of transaction data.
  3. monetary misstatements in populations of account balance details.

Terms:  Types of exceptions and concern when evaluating populations of accounting data

Diff:  Moderate

Objective:  LO 15-4

AACSB:  Reflective thinking

8) If the auditor concludes that the computer upper exception rate (CUER) is 5% at an 8% sampling risk, this means that the exception rate in the population is no greater than 5% with an 8% risk of the exception rate exceeding 5%.

Answer:  TRUE

Terms:  Estimate of population exception rate

Diff:  Moderate

Objective:  LO 15-4

AACSB:  Reflective thinking

 

9) The upper limit of the interval estimate is also known as the confidence interval.

Answer:  FALSE

Terms:  Computed upper exception rate (CUER)

Diff:  Moderate

Objective:  LO 15-4

AACSB:  Reflective thinking

 

10) Deviation refers to a departure from prescribed controls or amounts that are not monetarily correct.

Answer:  FALSE

Terms:  Deviation

Diff:  Easy

Objective:  LO 15-4

AACSB:  Reflective thinking

 

 

15.5   Learning Objective 15-5

 

1) The risk which the auditor is willing to take in accepting a control as being effective when the true population exception rate is greater than a tolerable rate is the

  1. A) finite correction factor.
  2. B) tolerable exception rate.
  3. C) acceptable risk of overreliance.
  4. D) estimated population exception rate.

Answer:  C

Terms:  Risk auditor is willing to take in accepting a control as being effective

Diff:  Easy

Objective:  LO 15-5

AACSB:  Reflective thinking

 

2) The exception rate the auditor will permit in the population and still be willing to conclude that the control is operating effectively is the

  1. A) tolerable exception rate.
  2. B) estimated population exception rate.
  3. C) acceptable risk of overreliance.
  4. D) sample exception rate.

Answer:  A

Terms:  Exception rate auditor will permit and still be willing to reduce assessed level of control risk

Diff:  Easy

Objective:  LO 15-5

AACSB:  Reflective thinking

3) If the auditor decides to assess control risk at the moderate level in a private company audit, when in previous years the auditor set control risk at the maximum level, then tests of controls for the current year would be

  1. A) increased in number.
  2. B) reduced in number.
  3. C) not performed.
  4. D) unchanged from prior planned settings.

Answer:  A

Terms:  Assess control risk

Diff:  Easy

Objective:  LO 15-5

AACSB:  Analytic thinking

 

 

4) When the computed upper exception rate (CUER) is greater than the tolerable exception rate (TER), it is necessary for the auditor to take specific action. Which of the following courses of action would be most difficult to justify?

  1. A) Reduce the tolerable exception rate so as to accept the sample results.
  2. B) Expand the sample size and perform more tests.
  3. C) Revise the assessed control risk upward.
  4. D) Write a letter to management which outlines the control deficiencies.

Answer:  A

Terms:  Computed upper exception rate is greater than tolerable exception rate

Diff:  Easy

Objective:  LO 15-5

AACSB:  Reflective thinking

 

5) Which of the following would have the least impact in determining sample size?

  1. A) acceptable risk of overreliance
  2. B) risk of assessing control risk too low
  3. C) tolerable exception rate
  4. D) population size

Answer:  D

Terms:  Least impact on determining sample size

Diff:  Easy

Objective:  LO 15-5

AACSB:  Reflective thinking

 

6) Which of the following represents the best description of the tolerable exception rate?

  1. A) the highest exception rate the auditor will permit in the control being tested and still conclude it is operating effectively
  2. B) the highest exception rate the auditor expects to find in the population
  3. C) the number of exceptions found in the sample divided by the sample size
  4. D) the highest estimated exception rate in a population at a given estimated population exception rate.

Answer:  A

Terms:  Tolerable exception rate

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

7) When analyzing exceptions, the auditor should keep in mind that

  1. A) all exceptions must be reported to management.
  2. B) they should determine the breakdown in the internal controls that allowed the exceptions to occur.
  3. C) the nature of an exception and its causes have no effect on the qualitative evaluation of the system.
  4. D) exceptions do not need to be analyzed if it is too costly.

Answer:  B

Terms:  Sample size and analyzing exceptions

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Analytic thinking

 

8) The exception rate that the auditor will permit in the population and still be willing to use the preliminary control risk assessment is called the

  1. A) acceptable exception rate.
  2. B) estimated population exception rate.
  3. C) sample exception rate.
  4. D) tolerable exception rate.

Answer:  D

Terms:  Exception rate; Preliminary control risk assessment

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

9) Auditors often use the ________ to determine the estimated population exception rate.

  1. A) current year’s audit results
  2. B) tolerable exception rate
  3. C) preceding year’s audit results
  4. D) estimated computed by management

Answer:  C

Terms:  Estimate of population exception rate

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

 

10) Place the following steps in their proper order:

  1. Analyze exceptions.
  2. Select the sample.
  3. Define attributes and exception conditions.
  4. State the objectives of the audit test.
  5. Specify the tolerable exception rate.
  6. A) 1, 3, 2, 4, 5.
  7. B) 4, 3, 1, 2, 5.
  8. C) 4, 3, 5, 2, 1.
  9. D) 1, 2, 3, 4, 5.

Answer:  C

Terms:  Auditing sampling steps

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

11) If an auditor judgmentally selects a sample of one hundred items from a population and finds two exceptions, the auditor

  1. A) can conclude that the sample exception rate is 2%.
  2. B) can conclude that the population exception rate is 2%.
  3. C) can calculate the highest exception rate expected in the population.
  4. D) cannot make any conclusions about either the sample or the population.

Answer:  A

Terms:  Sample selected from population and found exceptions

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

12) When planning the audit sample,

  1. A) one objective of the tests of controls is to test the effectiveness of the controls.
  2. B) audit sampling applies to analytical procedures.
  3. C) audit sampling generally applies to automated controls.
  4. D) the auditor must generalize from the sample to the population.

Answer:  A

Terms:  Planning the audit sample

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

 

13) Which of the following is the exception rate that the auditor expects to find before testing?

  1. A) sample exception rate
  2. B) estimated population exception rate
  3. C) computed exception rate
  4. D) tolerable exception rate

Answer:  B

Terms:  Exception rate auditor expects to find before testing

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

14) Which of the following is not a term related to evaluating results in audit sampling until after a sample is tested and evaluated?

  1. A) sample exception rate
  2. B) estimated population exception rate
  3. C) computed upper exception rate
  4. D) exception

Answer:  B

Terms:  Term not related to evaluating results in audit sampling

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

15) The relationship of tolerable exception rate (TER) to sample size is

  1. A) direct (larger TER = larger sample).
  2. B) inverse (larger TER = smaller sample).
  3. C) variable (sometimes larger, sometimes smaller).
  4. D) not determinable.

Answer:  B

Terms:  Relationship of tolerable exception rate (TER) to sample size

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

16) Which of the following must be set prior to testing a sample?

  1. A) sample exception rate
  2. B) achieved upper precision limit
  3. C) computed exception rate
  4. D) tolerable exception rate

Answer:  D

Terms:  Set prior to testing sample

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

 

17) The acceptable risk of overreliance

  1. A) is the risk that the auditor will erroneously conclude that the controls are less effective than they actually are.
  2. B) is less of a concern to the auditors than the risk of underreliance.
  3. C) represents the auditor’s measure of sampling risk.
  4. D) is determined by a statistical formula, and not by professional judgment.

Answer:  C

Terms:  Acceptable risk of overreliance

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

18) The sample exception rate equals

  1. A) the number of exceptions in the population divided by the sample size.
  2. B) the number of items in the population multiplied by the number of exceptions in the sample.
  3. C) the number of exceptions in the sample divided by the sample size.
  4. D) the number of exceptions in the population divided by the population size.

Answer:  C

Terms:  Sample exception rate

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

19) When defining the population,

  1. A) it may be necessary to define separate populations for different audit procedures.
  2. B) the auditor may generalize only about the population that has been sampled.
  3. C) auditors can define the population to include any items they want.
  4. D) all of the above

Answer:  D

Terms:  Population considered acceptable based on acceptable risk of assessing control risk too low; Upper exception rate

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

20) One way to evaluate sampling risk when nonstatistical sampling is used is to

  1. A) subtract the sample exception rate from the tolerable exception rate.
  2. B) add the sample exception rate and the tolerable exception rate.
  3. C) subtract the sample exception rate from the acceptable risk of overreliance.
  4. D) add the sample exception rate and the acceptable risk of overreliance.

Answer:  A

Terms:  Sampling risk

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

 

21) A danger in setting the acceptable risk of overreliance too low is

  1. A)
The risk that the auditor is willing to take of accepting a control as

ineffective when it is effective

 The risk that the auditor is willing to take of accepting a control as effective when it is ineffective
Yes Yes

 

  1. B)
The risk that the auditor is willing to take of accepting a control as

ineffective when it is effective

 The risk that the auditor is willing to take of accepting a control as effective when it is ineffective
No No

 

  1. C)
The risk that the auditor is willing to take of accepting a control as

ineffective when it is effective

 The risk that the auditor is willing to take of accepting a control as effective when it is ineffective
Yes No

 

  1. D)
The risk that the auditor is willing to take of accepting a control as

ineffective when it is effective

 The risk that the auditor is willing to take of accepting a control as effective when it is ineffective
No Yes

 

Answer:  D

Terms:  Acceptable risk of overreliance

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

22) When using statistical sampling, the auditor would most likely require a smaller sample if the

  1. A) population increases.
  2. B) desired reliability decreases.
  3. C) desired precision interval narrows.
  4. D) expected exception rate increases.

Answer:  B

Terms:  Statistical sampling; Auditor requires smaller sample

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

 

23) Whenever auditors use sampling, they risk making incorrect conclusions about the population. The risk that the auditor concludes that controls are more effective than they actually are is known as the

  1. A) risk of overreliance.
  2. B) risk of underreliance.
  3. C) risk that the sample is not representative of the population.
  4. D) risk that the sample conclusions cannot be useful because of nonprobability sampling.

Answer:  A

Terms:  Sampling and the risk of making incorrect conclusions about the population

Diff:  Challenging

Objective:  LO 15-5

AACSB:  Reflective thinking

 

24) When choosing the appropriate acceptable risk of overreliance, the auditor needs to

  1. A) rely on his/her professional judgment.
  2. B) err on the side of conservatism.
  3. C) consult the professional standards.
  4. D) follow SEC guidelines.

Answer:  A

Terms:  Acceptable risk of overreliance

Diff:  Challenging

Objective:  LO 15-5

AACSB:  Reflective thinking

 

25) When planning the audit sample, the ________ is (are) those items about which the auditor wishes to generalize.

  1. A) attributes
  2. B) sampling unit
  3. C) population
  4. D) sample

Answer:  C

Terms:  Population and sampling unit

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

26) If the result obtained from a particular sample for control and substantive tests of transactions is critical to the formation of an audit opinion, which of the following is the most important to the auditor in concluding of the appropriateness and sufficiency of evidence gathered?

  1. A) acceptable risk of overreliance
  2. B) estimated population exception rate
  3. C) tolerable exception rate
  4. D) size of the population

Answer:  A

Terms:  Control and substantive tests of transactions; Important in concluding appropriateness and sufficiency of evidence

Diff:  Challenging

Objective:  LO 15-5

AACSB:  Reflective thinking

 

27) There is a(n) ________ relationship between acceptable risk of overreliance and planned sample size.

  1. A) direct
  2. B) inverse
  3. C) proportional
  4. D) exponential

Answer:  B

Terms:  Acceptable risk of overreliance

Diff:  Challenging

Objective:  LO 15-5

AACSB:  Reflective thinking

 

28) Which of the following results in a larger sample size?

  1. A) Decrease the estimated population exception rate and decrease the tolerable exception rate.
  2. B) Increase the estimated population exception rate and decrease the tolerable exception rate.
  3. C) Decrease the estimated population exception rate and increase the tolerable exception rate.
  4. D) Increase the estimated population exception rate and increase the tolerable exception rate.

Answer:  B

Terms:  Results in larger sample size

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

29) When determining tolerable exception rate (TER),

  1. A) the auditor considers the degree of reliance to be placed on the control and the significance of the control to the audit.
  2. B) if only one internal control is used to support a low control risk assessment for an objective, TER will be higher for the attribute than if multiple controls are used to support a low control risk assessment for the same objective.
  3. C) control deviations increase both the risk of material misstatements in the accounting record, and will always result in misstatements.
  4. D) a smaller sample size is needed for a low TER than for a high TER.

Answer:  A

Terms:  Tolerable exception rate

Diff:  Challenging

Objective:  LO 15-5

AACSB:  Reflective thinking

 

30) The acceptable risk of overreliance

  1. A) is normally assessed at a high level when auditing an accelerated filer public company.
  2. B) and the extent of tests of controls depends on assessed control risk for accelerated filer public companies.
  3. C) and the control risk will be assessed as low for audits where there is extensive reliance on internal controls.
  4. D) does not impact the effectiveness of the audit.

Answer:  C

Terms:  Acceptable risk of overreliance

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

31) You are determining the appropriate sample size to test accounts receivable. What three factors are the most important to consider?

Answer:

  1. tolerable exception rate (TER)
  2. acceptable risk of overreliance (ARO)
  3. estimated population exception rate (EPER)

Terms:  Factors to determine appropriate sample size

Diff:  Easy

Objective:  LO 15-5

AACSB:  Reflective thinking

 

 

32) Explain the effect on sample size of increasing each of the following: (1) tolerable exception rate, (2) estimated population exception rate, (3) acceptable risk of overreliance, and (4) population size.

Answer:  The tolerable exception rate and acceptable risk of overreliance are inversely related to sample size; that is, as TER or ARO increase, sample size will decrease. The estimated population exception rate and the population size are directly related to sample size; that is, as EPER increases, sample size will also increase, and as population size increases, sample size may slightly increase.

Terms:  Effects on sample size when increasing tolerable exception, estimated population exception rate, acceptable risk of assessing control risk too low, and population size

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

33) The auditor must use the same TER and ARO levels for all attributes of an audit test.

Answer:  FALSE

Terms:  Acceptable risk of overreliance

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

34) The tolerable exception rate is the rate that the auditor will permit in the population and still be willing to conclude a control is effective.

Answer:  TRUE

Terms:  Tolerable exception rate

Diff:  Easy

Objective:  LO 15-5

AACSB:  Reflective thinking

 

35) The only way to know with certainty whether a sample is representative is to subsequently audit the entire population.

Answer:  TRUE

Terms:  Know with certainty whether sample is representative is to audit entire population

Diff:  Moderate

Objective:  LO 15-1 and LO 15-5

AACSB:  Reflective thinking

 

36) Acceptable risk of overreliance is the risk that the auditor is willing to take in accepting a control as effective when the true population exception rate is greater than the estimated population exception rate.

Answer:  FALSE

Terms:  Acceptable risk of overreliance

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

 

37) Acceptable risk of overreliance is normally lower for a public company audit than a private company audit.

Answer:  TRUE

Terms:  Acceptable risk of overreliance

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

Topic:  Public

 

38) When the estimated population exception rate exceeds the sample exception rate, the auditor can conclude that the sample results do not support the preliminary assessed control risk.

Answer:  FALSE

Terms:  Sample exception rate

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

39) When the sample exception rate is greater than the tolerable exception rate in attributes sampling, one possible appropriate course of action is to increase sample size.

Answer:  TRUE

Terms:  Sample exception rate and tolerable exception rate

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

40) Tolerable exception rate (TER) is inversely related to sample size.

Answer:  TRUE

Terms:  Tolerable exception rate and sample size relationship

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

41) When the sample exception rate (SER) exceeds the tolerable exception rate (TER), the auditor should decide whether to increase sample size or to revise assessed control risk on the basis of cost versus benefit.

Answer:  FALSE

Terms:  Control risk assessment

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

 

42) In nonstatistical sampling, the calculated sampling error is the difference between the tolerable exception rate and the sample exception rate.

Answer:  TRUE

Terms:  Nonstatistical sampling; Calculated sampling error

Diff:  Challenging

Objective:  LO 15-5

AACSB:  Reflective thinking

 

43) The sampling unit is the physical unit that corresponds to the random numbers the auditor generates.

Answer:  TRUE

Terms:  Sampling unit

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

 

44) The sum of the tolerable exception rate and the estimated population exception rate is the precision of the initial sample estimate.

Answer:  FALSE

Terms:  Determining sample size

Diff:  Moderate

Objective:  LO 15-5

AACSB:  Reflective thinking

15.6   Learning Objective 15-6

 

1) Rodgers CPA believes that the rate of client billing errors is 4% and has established a tolerable deviation rate of 6%. In auditing client invoices Rodgers should use

  1. A) stratified sampling.
  2. B) classical sampling.
  3. C) proportional sampling.
  4. D) attributes sampling.

Answer:  D

Terms:  Auditing client invoices

Diff:  Easy

Objective:  LO 15-6

AACSB:  Analytic thinking

 

 

2) Attributes sampling would be an appropriate method to use on which one of the following procedures in an audit program?

  1. A) Review sales transactions for large and unreasonable amounts.
  2. B) Observe whether the duties of the accounts receivable clerk are separate from handling cash.
  3. C) Examine a sample of duplicate sales invoices for credit approval by the credit manager.
  4. D) Review the aged schedule of accounts receivable to determine if receivables from officers are included.

Answer:  C

Terms:  Attributes sampling

Diff:  Moderate

Objective:  LO 15-6

AACSB:  Reflective thinking

 

3) Attributes sampling is based on the ________ distribution, in which each possible sample in the population has one of two possible values, such as yes or no.

  1. A) random
  2. B) binomial
  3. C) statistical
  4. D) nonstatistical

Answer:  B

Terms:  Attribute sampling and binomial distribution

Diff:  Easy

Objective:  LO 15-6

AACSB:  Reflective thinking

 

4) For which of the following audit procedures would audit sampling not be appropriate?

  1. A) Review sales transactions for large and unusual amounts.
  2. B) Examine a sample of duplicate sales invoices for credit approval.
  3. C) Compare the quantity on duplicate sales invoices with the quantity on related shipping documents.
  4. D) Audit sampling is appropriate for each of the above procedures.

Answer:  A

Terms:  Audit sampling not appropriate for which audit procedure

Diff:  Challenging

Objective:  LO 15-6

AACSB:  Reflective thinking

 

5) Which of the following is one of the main differences between attributes sampling and nonstatistical sampling?

  1. A) the number of steps involved
  2. B) the calculation of the initial sample sizes
  3. C) determining the objectives of the audit test
  4. D) defining the population

Answer:  B

Terms:  Differences between attributes sampling and nonstatistical sampling

Diff:  Moderate

Objective:  LO 15-6

AACSB:  Reflective thinking

 

6) Which of the following is an accurate statement regarding sampling distribution?

  1. A) A sampling distribution is a sample with characteristics the same as those of the population.
  2. B) Sampling distributions allow the auditor to make probability statements about the likely representativeness of any sample that is in the distribution.
  3. C) Each population exception rate and sample size has the same sampling distribution.
  4. D) Auditors cannot use sampling distributions to draw statistical conclusions about the unknown population being sampled.

Answer:  B

Terms:  Sampling distribution

Diff:  Moderate

Objective:  LO 15-6

AACSB:  Reflective thinking

 

7) Auditors base their statistical inferences on sampling distributions.

Answer:  TRUE

Terms:  Sampling distribution

Diff:  Moderate

Objective:  LO 15-6

AACSB:  Reflective thinking

 

15.7   Learning Objective 15-7

 

1) A principal advantage of statistical methods of attributes sampling over nonstatistical methods is that they provide a quantifiable basis for establishing the

  1. A) risk of assessing control risk too low.
  2. B) tolerable exception rate.
  3. C) expected population exception rate.
  4. D) sample size.

Answer:  D

Terms:  Advantage of statistical methods of attributes sampling

Diff:  Moderate

Objective:  LO 15-7

AACSB:  Reflective thinking

 

2) In using sampling distribution for attributes, which one of the following must be known to evaluate the sample results?

  1. A) estimated dollar value of the population
  2. B) standard exception of the values in the population
  3. C) actual exception rate of the attribute in the population
  4. D) sample size

Answer:  D

Terms:  Estimation sampling for attributes

Diff:  Moderate

Objective:  LO 15-7

AACSB:  Reflective thinking

 

3) When evaluating the results of attributes sampling,

  1. A) the acceptable risk of overreliance (ARO) is set at high or low.
  2. B) tables are used to compute the computed upper exception rate (CUER).
  3. C) if the sample size is not equal to those provided for in the attributes sampling evaluation tables, the tables cannot be used.
  4. D) the true exception rate is computed from various tables.

Answer:  B

Terms:  Attributes sampling application

Diff:  Challenging

Objective:  LO 15-7

AACSB:  Reflective thinking

 

4) When deciding the acceptability of the population,

  1. A) the methodology for deciding the acceptability of the population for attributes differs from determining the acceptability for nonstatistical sampling.
  2. B) before the population can be considered acceptable, the CUER determined on the basis of the actual sample results must be less than or equal to TER when both are based on the same ARO.
  3. C) when the CUER is greater than the TER, the auditor must increase the sample size.
  4. D) the CUER is compared with the TER in total, not for each attribute.

Answer:  B

Terms:  Acceptability of the population and attribute sampling

Diff:  Challenging

Objective:  LO 15-7

AACSB:  Reflective thinking

 

 

5) When planning the sample,

  1. A) auditors using attributes sampling assign a low, medium, or high acceptable risk of overreliance.
  2. B) tables are used by the auditor in statistical sampling to determine initial sample size.
  3. C) most auditors use attributes sampling for medium to small populations.
  4. D) the tolerable exception rate does not need to be specified for statistical sampling.

Answer:  B

Terms:  Planning the audit sample

Diff:  Challenging

Objective:  LO 15-7

AACSB:  Reflective thinking

6) As the auditor, you are assessing the proper sample size to use in testing controls. When using attributes sampling, which of the following is most correct?

  1. A) A 10% change in population size will have the least effect on sample size.
  2. B) A 10% change in the tolerable deviation rate will have the least effect on sample size.
  3. C) A 10% change in the expected deviation rate will have the least effect on sample size.
  4. D) A 10% change in the tolerable will have the least effect on sample size.

Answer:  A

Terms:  Attributes sampling

Diff:  Moderate

Objective:  LO 15-7

AACSB:  Reflective thinking

 

7) In attributes sampling, an estimate of the expected population exception rate is necessary to plan the sample size. The relationship of expected population exception rate (EPER) to sample size is

  1. A) direct (small EPER = small sample).
  2. B) inverse (small EPER = large sample).
  3. C) a variable (sometimes small, sometimes large) dependent on other factors present.
  4. D) indeterminate.

Answer:  A

Terms:  Attributes sampling; Expected population exception rate and sample size

Diff:  Moderate

Objective:  LO 15-7

AACSB:  Reflective thinking

 

 

8) There are 14 steps to attributes sampling, divided into three sections: plan the sample, select the sample and perform the audit procedures, and evaluate the results. Discuss the three steps that comprise the “evaluate the results” section.

Answer:  The steps that comprise the “evaluate the results” section in attributes sampling are:

  1. Generalize from the sample to the population. Tables can be used to determine the upper precision limit (computed upper exception rate) at a specified acceptable risk of overreliance.
  2. Analyze exceptions. In this step, the auditor should analyze individual exceptions to determine the breakdown in the internal controls that caused them.
  3. Decide the acceptability of the population. In the final step, the auditor compares the computed upper exception rate with the tolerable exception rate for each attribute. If the computed upper exception rate is less than or equal to the tolerable exception rate, then the population is considered acceptable.

Terms:  Steps that comprise evaluate the results section of 14 steps to attributes sampling

Diff:  Challenging

Objective:  LO 15-7

AACSB:  Reflective thinking

 

9) Statistical sampling eliminates any professional judgment for the auditor.

Answer:  FALSE

Terms:  Statistical sampling and professional judgment

Diff:  Moderate

Objective:  LO 15-7

AACSB:  Reflective thinking

10) Because attributes sampling is a statistical sampling approach, it allows the auditor to quantify the allowance for sampling risk and the upper exception rate.

Answer:  TRUE

Terms:  Evaluating sample results

Diff:  Moderate

Objective:  LO 15-7

AACSB:  Reflective thinking

 

11) In selecting the sample, probabilistic methods must be used for both statistical and nonstatistical sampling.

Answer:  FALSE

Terms:  Selecting the sample size

Diff:  Easy

Objective:  LO 15-7

AACSB:  Reflective thinking

 

Auditing and Assurance Services, 16e (Arens/Elder/Beasley)

Chapter 25   Other Assurance Services

 

25.1   Learning Objective 25-1

 

1) The standards for preparation, compilation, and review engagements of financial statements are the

  1. A) AICPA’s Code of Professional Conduct.
  2. B) Statements on Auditing Standards (SASs).
  3. C) Statements of Standards on Attestation Engagements (SSAEs).
  4. D) Statements on Standards for Accounting and Review Services (SSARS).

Answer:  D

Terms:  Review, compilation, and preparation services

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

 

2) Two of the types of services provided in connection with the Statements on Standards for Accounting and Review Services are

  1. A) audit and examination services.
  2. B) compilation and review services.
  3. C) examination and review services.
  4. D) management advisory services and compilations.

Answer:  B

Terms:  Statements on Standards for Accounting and Review Services (SSARS)

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

 

3) Practitioners who perform preparation, compilation, or review engagements are referred to in the Statements on Standards for Accounting and Review Services (SSARS) standards as

  1. A) bookkeepers.
  2. B) accountants.
  3. C) auditors.
  4. D) CPAs.

Answer:  B

Terms:  Preparation, compilation, and review engagements; SSARS standards

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

 

 

4) Compilation reports may be of all except which of the following types?

  1. A) compilation with limited independence
  2. B) compilation with full disclosure
  3. C) compilation without independence
  4. D) compilation that omits substantially all disclosures

Answer:  A

Terms:  Compilation reports

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

5) A CPA firm can issue a compilation report

  1. A) only if the partners are independent.
  2. B) only if all the partners and the staff in the office performing the engagement are independent.
  3. C) if the partners have no material or direct immaterial interest in client.
  4. D) even if it is not independent.

Answer:  D

Terms:  Compilation reports

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

 

6) Which of the following would not be included in a CPA’s report based upon a review of the financial statements of a nonpublic entity?

  1. A) a statement that the review was in accordance with generally accepted auditing standards
  2. B) a statement that all information included in the financial statements is the representation of management
  3. C) a statement that the review primarily consists of analytical procedures and inquiries
  4. D) a statement that the accountant has conducted a review

Answer:  A

Terms:  CPA’s report; Review of financial statements; Nonpublic entity

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

 

7) The statement that “We are not aware of any material modifications that should be made to the accompanying financial statements” expresses which of the following?

  1. A) disclaimer of an opinion
  2. B) negative assurance
  3. C) negative confirmation
  4. D) shared opinion

Answer:  B

Terms:  Negative assurance

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

 

8) For compilations, an accountant does which of the following?

  1. A)
Obtain an understanding of internal control. Perform tests of

controls.

Perform tests of transactions.
Yes Yes No

 

  1. B)
Obtain an understanding of internal control. Perform tests of

controls.

Perform tests of transactions.
Yes No Yes

 

  1. C)
Obtain an understanding of internal control. Perform tests of

controls.

Perform tests of transactions.
No Yes Yes

 

  1. D)
Obtain an understanding of internal control. Perform tests of

controls.

Perform tests of transactions.
No No No

 

Answer:  D

Terms:  Compilation

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

9) The concept of limited assurance is provided for in which of the following engagements?

  1. A) audit
  2. B) review
  3. C) compilation
  4. D) agreed-upon procedures

Answer:  B

Terms:  Limited assurance; Engagements

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

10) Evidence for a review engagement consists primarily of

  1. A)
Inquiries Analytical procedures Tests of details
No Yes No

 

  1. B)
Inquiries Analytical procedures Tests of details
Yes Yes No

 

  1. C)
Inquiries Analytical procedures Tests of details
No No Yes

 

  1. D)
Inquiries Analytical procedures Tests of details
Yes No Yes

 

Answer:  B

Terms:  Evidence for review engagement

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

11) When the accountant has performed a review and has determined that no material changes to the financial statements are needed, the first paragraph of the review report

  1. A) expresses positive assurance about the financial statements.
  2. B) notes the accountant’s responsibility to conduct the review.
  3. C) identifies the entity and the period of financial statements subject to the review.
  4. D) specifies that management is responsible for the financial statements.

Answer:  C

Terms:  Review of financial statement; Report

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

12) The highest level of assurance is provided for in which one of the following engagements?

  1. A) review
  2. B) compilation
  3. C) audit
  4. D) preparation service

Answer:  C

Terms:  Concept of reasonable assurance

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Analytic thinking

 

13) You are preparing to issue a report on the compilation of financial statements for a nonpublic company. Prior to issuing the report you should

  1. A) read the financial statements to determine if they are free from obvious material errors.
  2. B) perform analytical procedures to determine if they are free from material misstatements.
  3. C) perform tests of balances on selected accounts to determine if they are free from material misstatements.
  4. D) perform limited control tests to determine if there are any material misstatements.

Answer:  A

Terms:  Report on the compilation of financial statements for nonpublic company

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Analytic thinking

 

14) Which of the following statements is true regarding review and audit services?

  1. A) A review requires more substantive evidence than an audit.
  2. B) An audit requires less evidence related to internal control than a review.
  3. C) A review requires less evidence than an audit.
  4. D) None of the above statements is true.

Answer:  C

Terms:  Assurance; Review

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

15) An accountant who reviews the financial statements of a nonpublic entity should issue a report stating that a review

  1. A) is substantially equivalent in scope to an audit.
  2. B) is substantially more in scope than a compilation.
  3. C) is substantially less in scope than an audit.
  4. D) provides only minimal assurance that the financial statements are fairly presented.

Answer:  C

Terms:  Review of financial statement; Report

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

16) An accountant has accepted an engagement in which the audit procedures of inquiry and analytical procedures will be employed. These procedures will form the basis for issuance of

  1. A) a compilation report.
  2. B) an audit report on supplemental information issued by the client.
  3. C) a management advisory report requested by the audit committee.
  4. D) a review report on financial statements for a nonpublic company.

Answer:  D

Terms:  Engagement with audit procedures of inquiry and analytically procedures

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

17) All of the following are steps that should be performed in a review engagement except for

  1. A) understand the company’s ownership structure.
  2. B) read the company’s financial statements.
  3. C) perform analytical procedures.
  4. D) assess fraud risk.

Answer:  D

Terms:  Review of a nonpublic entity’s financial statements

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Analytic thinking

 

18) In a review service where the client has failed to follow applicable accounting standards, the accountant is

  1. A) not required to determine the effect of a departure if management has not done so, but that fact must be disclosed in the report.
  2. B) required to determine the effect of a departure if management has not done so, and that fact must be disclosed in the report.
  3. C) not required to determine the effect of a departure if management has not done so, and that fact need not be disclosed in the report.
  4. D) required to determine the effect of a departure if management has not done so, and that fact need not be disclosed in the report.

Answer:  A

Terms:  Review service where client failed to follow applicable accounting standards

Diff:  Challenging

Objective:  LO 25-1

AACSB:  Reflective thinking

 

19) Your accounting firm has accepted a compilation engagement from a client in which your firm is not independent. In that case you

  1. A) may not accept the engagement.
  2. B) may accept the engagement and disclose the lack of independence.
  3. C) may accept the engagement and not disclose the lack of independence.
  4. D) may accept the engagement and disclose the lack of independence and the reason for the lack of independence.

Answer:  B

Terms:  Compilation engagement; Firm not independent

Diff:  Challenging

Objective:  LO 25-1

AACSB:  Analytic thinking

 

 

20) One of the first steps that should be performed for a review of a nonpublic entity’s financial statements is to

  1. A) read the financial statements.
  2. B) obtain knowledge of the accounting principles and practices of the client’s industry.
  3. C) inquire whether management has omitted substantially all of the disclosures required by applicable accounting standards.
  4. D) apply analytical procedures to provide limited assurance that no material modifications should be made to the financial statements.

Answer:  B

Terms:  Review of a nonpublic entity’s financial statements

Diff:  Challenging

Objective:  LO 25-1

AACSB:  Reflective thinking

21) Each page of the financial statements reviewed for a nonpublic entity should include the reference

  1. A) “These financial statements are unaudited.”
  2. B) “We express no assurance on these financial statements.”
  3. C) “See independent accountant’s review report.”
  4. D) “See the audit opinion for the review procedures performed.”

Answer:  C

Terms:  Review of financial statement; Report

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Analytic thinking

 

22) The last paragraph of the accountant’s review report

  1. A) details the responsibilities of management.
  2. B) details the responsibilities of the accountant.
  3. C) expresses limited assurance in the form of negative assurance.
  4. D) lists the analytical procedures performed.

Answer:  C

Terms:  Review of financial statement; Report

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

 

23) Which of the following is a correct statement regarding review, compilation, and preparation services?

  1. A) A written engagement letter is not needed for a review, compilation or preparation service.
  2. B) The Statements on Standards for Accounting and Review Services (SSARS) clarity project used international standards as the base standard when revising the SSARS.
  3. C) CPAs must be independent of the client in a review service engagement and for an audit engagement.
  4. D) The amount of evidence accumulated in a review is minimal.

Answer:  C

Terms:  Preparation, compilation, and review engagements; SSARS standards

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

24) When performing a review service, auditors must make inquiries of management. Which of the following inquiries are typically made of management?

  1. A) Is each account on the financial statements prepared in conformity with accounting standards and consistently applied?
  2. B) What unusual or significant transactions occurred this year?
  3. C) Do you have knowledge of an actual or suspected fraud?
  4. D) All of the above are inquiries typically made of management.

Answer:  D

Terms:  Review of a nonpublic entity’s financial statements

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

25) In a preparation service engagement,

  1. A) the CPA’s responsibilities are similar to those performed during a review.
  2. B) the CPA does not provide any assurance of the financial statements.
  3. C) the CPA must issue a preparation service engagement report.
  4. D) the CPA must be independent.

Answer:  B

Terms:  Preparation services

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

 

26) A financial statement review conducted in compliance with Statements on Standards for Accounting and Review Services (SSARS) requires the accountant to obtain evidence to express negative assurance. One of these procedures is to “perform analytical procedures.” List three other procedures the accountant must perform.

Answer:

  • Obtain agreement on engagement terms.
  • Obtain knowledge of the accounting principles and practices of the client’s industry.
  • Obtain knowledge of the client; that is understand, the nature of the client’s business transactions, its accounting records and employees, the ownership structure, the key personnel, the accounting principles and practices used by the client, and the content of the financial statements.
  • Make inquiries of management to determine whether the financial statements are fairly presented.
  • Read the financial statements to determine whether they conform with the financial reporting framework.
  • Reconcile the financial statements to the underlying accounting records.
  • Obtain a letter of representation from members of management who are knowledgeable about financial matters.
  • Prepare documentation that is sufficient in detail to provide a clear understanding of the work performed, the review evidence obtained, and its source, and the conclusions reached.

Terms:  SSARS; Financial statement review activities

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

27) Discuss each of the three types of compilation reports and the circumstances in which each should be used.

Answer:

  • Compilation with full disclosure. This report is used when the financial statements include all disclosures required by accounting standards.
  • Compilation that omits substantially all disclosures. This type of report is used when the financial statements are compiled without disclosures. This type of report is acceptable if the report indicates the lack of disclosures and the absence of disclosures is not, to the CPA’s knowledge, undertaken with the intent to mislead users. Typically, this type of statement is used primarily for management purposes. Appropriate wording is added after the conclusion paragraph of the standard compilation report.
  • Compilation without independence. A CPA firm can issue a compilation report will full or omitted disclosures even if it is not independent of the client. If the accountant is not independent with respect to the client, the compilation report should include, as a separate last paragraph, a statement to that effect.

Terms:  Compilation reports

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

 

28) Draft a report that would be appropriate when an independent accountant has performed a compilation of financial statements with disclosures in accordance with accounting principles generally accepted in the United States of America.

Answer:  Management is responsible for the accompanying financial statements of XYZ Company, which comprise the balance sheet as of December 31, 201X, and the related statements of income, changes in stockholders’ equity and cash flows for the year then ended, and the related notes to the financial statements in accordance with accounting principles generally accepted in the United States of America. We have performed the compilation engagement in accordance with Statements on Standards for Accounting and Review Services promulgated by the Accounting and Review Services Committee of the AICPA. We did not audit or review the financial statements nor were we required to perform any procedures to verify the accuracy or completeness of the information provided by management. Accordingly, we do not express an opinion, a conclusion, nor provide any form of assurance on these financial statements.

Terms:  Report on compilation of financial statements with disclosures in accordance with GAAP

Diff:  Challenging

Objective:  LO 25-1

AACSB:  Analytic thinking

29) Discuss the six Statements on Standards for Accounting and Review Services (SSARS) requirements that must be met when an accountant is performing a compilation of financial statements.

Answer:  The preparer of the statements must:

  • Establish an understanding with the client in a written engagement letter or other suitable form of written agreement about the objectives of the compilation engagement, type and limitations of the services to be provided, including acknowledgement that the accountant does not provide any assurance about the financial statements, and a description of the report, if a report is to be issued.
  • Possess knowledge about the accounting principles and practices of the client’s industry.
  • Know the client, including a general understanding of the client’s organization, the nature of its business transactions, the accounting principles and practices used by the client, and the content of its financial statements.
  • Make inquiries to determine whether the client’s information is satisfactory.
  • Read the compiled financial statements and be alert for any obvious omissions or errors in arithmetic and in the application of accounting standards.
  • Request management to provide additional or corrected information if the accountant becomes aware that the records, documents, explanations, or other information, including significant judgments by management, is incomplete, inaccurate, or otherwise unsatisfactory.
  • Prepare documentation in sufficient detail to provide a clear understanding of the work performed and any findings or issues that are significant, including any communications with management regarding fraud or illegal acts that came to the accountant’s attention.

Terms:  SSARS requirements for compilation of financial statements

Diff:  Challenging

Objective:  LO 25-1

AACSB:  Reflective thinking

 

30) When performing a review service and the accountant becomes aware that fraud may have occurred, the accountant must withdraw from the engagement.

Answer:  FALSE

Terms:  Review services

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

31) If an auditor performs a compilation but lacks independence, an additional paragraph must be added which states that: “We are not independent with respect to XYZ Company.”

Answer:  TRUE

Terms:  Compilation engagement; Firm not independent

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

32) Review reports are normally dated as of the client’s balance sheet date.

Answer:  FALSE

Terms:  Review reports dated

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

33) Statements on Standards for Accounting and Review Services (SSARS) are issued by the SEC.

Answer:  FALSE

Terms:  SSARS

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

 

34) A nonaudit engagement in which the accountant undertakes to present, in the form of financial statements, information that is the representation of management, without undertaking to express any assurance on the statements is called a review engagement.

Answer:  FALSE

Terms:  Nonaudit engagement; review engagement

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

 

35) CPAs must be independent to issue a compilation report.

Answer:  FALSE

Terms:  Compilation report; Independence

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

 

36) CPAs must be independent to issue a review report.

Answer:  TRUE

Terms:  Review report; Independence

Diff:  Easy

Objective:  LO 25-1

AACSB:  Reflective thinking

 

37) A financial statement review conducted in compliance with Statements on Standards for Accounting and Review Services (SSARS) includes obtaining an understanding of internal control.

Answer:  FALSE

Terms:  Financial statement review; SSARS; Internal control

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

38) Statements on Standards for Accounting and Review Services (SSARS) govern the CPA’s association with unaudited financial statements of nonpublic companies.

Answer:  TRUE

Terms:  Statements on Standards for Accounting and Review Services (SSARS)

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

39) When performing a review (SSARS review) of financial statements, the accountant is required to obtain a letter of representation from management.

Answer:  TRUE

Terms:  Review of financial statements; Letter of representation from management

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

40) When performing compilation services, the accountant is not required to obtain an understanding of the client’s internal control.

Answer:  TRUE

Terms:  Compilation services; Client internal control

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

41) A CPA firm can issue a compilation report even if it is not independent with respect to the client.

Answer:  TRUE

Terms:  Compilation report; Independence

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

42) When performing a preparation service, the CPA must issue a report and must be independent.

Answer:  FALSE

Terms:  Preparation services

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

43) For a preparation service, each page of the financial statements, should indicate, at a minimum, that “no assurance is provided” on the financial statements.

Answer:  TRUE

Terms:  Preparation services

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

 

44) In a preparation service, if the financial statements are expected to be used by a third party, the accountant must provide at least minimal assurance on the financial statements.

Answer:  FALSE

Terms:  Preparation services

Diff:  Moderate

Objective:  LO 25-1

AACSB:  Reflective thinking

25.2   Learning Objective 25-2

 

1) An interim review of the financial information for public companies is performed following standards of the

  1. A) American Institute of Certified Public Accountants (AICPA).
  2. B) Public Company Accounting Oversight Board (PCAOB).
  3. C) Securities and Exchange Commission (SEC).
  4. D) Statements on Standards for Accounting and Review Services (SSARS).

Answer:  B

Terms:  Review of interim information of public company

Diff:  Moderate

Objective:  LO 25-2

AACSB:  Reflective thinking

 

 

2) The Securities and Exchange Commission requires quarterly financial information as a part of the

  1. A) 10-K report.
  2. B) 10-Q report.
  3. C) 8-K report.
  4. D) auditor’s report.

Answer:  B

Terms:  Securities and Exchange Commission; Quarterly financial information

Diff:  Moderate

Objective:  LO 25-2

AACSB:  Reflective thinking

Topic:  Public

 

3) The quarterly reports submitted to the SEC by the client

  1. A) have to be audited and the CPA firm must be identified.
  2. B) do not have to be audited, but the CPA firm which does the annual audit must be identified.
  3. C) have to be audited, but the CPA firm does not have to be identified.
  4. D) do not have to be audited, but the CPA firm which does the annual audit must review the quarterly statements before they are submitted to the SEC.

Answer:  D

Terms:  Quarterly reports; SEC

Diff:  Moderate

Objective:  LO 25-2

AACSB:  Reflective thinking

Topic:  Public

 

4) When performing a review of interim information for a public company, the accountant ordinarily does not perform tests of the accounting records, independent confirmations, or physical examinations.

Answer:  TRUE

Terms:  Review of interim information of public company

Diff:  Moderate

Objective:  LO 25-2

AACSB:  Reflective thinking

Topic:  Public

5) The auditor must obtain evidence that the interim financial information agrees or reconciles with the accounting records for a public company interim review.

Answer:  TRUE

Terms:  Review of interim information of public company

Diff:  Moderate

Objective:  LO 25-2

AACSB:  Reflective thinking

 

 

25.3   Learning Objective 25-3

 

1) Statements on Standards for Attestation Engagements are established by the

  1. A) Securities and Exchange Commission.
  2. B) Public Company Accounting Oversight Board.
  3. C) Auditing Standards Board of the AICPA.
  4. D) Accounting and Review Services Committee.

Answer:  C

Terms:  Statements on Standards for Attestation Engagements

Diff:  Easy

Objective:  LO 25-3

AACSB:  Reflective thinking

 

2) As a CPA, you have been engaged to perform an attestation engagement. You would typically

  1. A) express a conclusion about an assertion.
  2. B) provide management consulting services.
  3. C) prepare financial forecasts to secure in preparation for receiving debt funding.
  4. D) compile financial statements for the client.

Answer:  A

Terms:  CPA; Attestation engagement

Diff:  Easy

Objective:  LO 25-3

AACSB:  Reflective thinking

 

3) Which of the following attestation engagements result in a conclusion that represents positive assurance?

  1. A) review
  2. B) compilation
  3. C) examination
  4. D) agreed upon procedure engagement

Answer:  C

Terms:  Positive assurance

Diff:  Easy

Objective:  LO 25-3

AACSB:  Reflective thinking

4) A review results in a conclusion that represents ________ assurance.

  1. A) limited assurance
  2. B) negative
  3. C) positive
  4. D) unequivocal

Answer:  B

Terms:  Negative assurance

Diff:  Easy

Objective:  LO 25-3

AACSB:  Reflective thinking

 

5) The distribution of which of the following types of reports is unrestricted?

  1. A) examinations and reviews
  2. B) reviews and agreed-upon procedures
  3. C) examinations and agreed-upon procedures
  4. D) examinations, reviews, and agreed-upon procedures

Answer:  A

Terms:  Restricted distribution of reports

Diff:  Easy

Objective:  LO 25-3

AACSB:  Reflective thinking

 

6) Which of the following is a generally accepted attestation standard for fieldwork?

  1. A) The practitioner must state in the report that the report is intended solely for the information and use of specified parties.
  2. B) The practitioner must state all of their significant reservations about the engagement.
  3. C) The practitioner must adequately plan the work and must properly supervise any assistants.
  4. D) The practitioner must exercise due professional care in the planning and performance of the engagement and the preparation of the report.

Answer:  C

Terms:  Specific attestation standards

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

7) Reports on agreed-upon procedures are intended to be distributed

  1. A) to only the involved parties, who would have the requisite knowledge about those procedures and the level of assurance resulting from them.
  2. B) to only the involved parties, who would have the requisite knowledge about those procedures but not the level of assurance resulting from them.
  3. C) to any party to whom the client wishes.
  4. D) only to the stockholders of the client.

Answer:  A

Terms:  Reports on agreed-upon procedures

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

8) Distribution of which of the following types of reports is limited?

  1. A) audit
  2. B) review
  3. C) agreed-upon procedures
  4. D) examination

Answer:  C

Terms:  Distribution of reports limited

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

9) Which of the following is an attestation standard under the standards of reporting?

  1. A) The practitioner must have adequate technical training.
  2. B) The practitioner must adequately plan the work.
  3. C) The practitioner must evaluate internal controls.
  4. D) The practitioner must identify the subject matter or assertion being reported on.

Answer:  D

Terms:  Attestation engagement; Statements on Standards for Attestation Engagements

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

10) Which of the following is not a standard contained in both the Attestation Standards and Generally Accepted Auditing Standards?

  1. A) The examination is to be performed by a person having adequate technical training.
  2. B) An independence in mental attitude is to be maintained.
  3. C) Sufficient evidence is to be obtained.
  4. D) The practitioner must obtain a sufficient understanding of the client’s internal control.

Answer:  D

Terms:  Attestation standard; Standards of fieldwork

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

11) Which of the following is not one of the types of engagements and related forms of conclusions that are defined by the attestation standards?

  1. A) reviews
  2. B) compilations
  3. C) examinations
  4. D) agreed-upon procedures

Answer:  B

Terms:  Attestations; Conclusions; Attestation standards

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

12) Which of the following types of engagement reports would provide positive assurance?

  1. A) an examination
  2. B) a review
  3. C) an agreed-upon procedures engagement
  4. D) a compilation

Answer:  A

Terms:  Engagement reports; Positive assurance

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

13) An agreed-upon procedures engagement is one in which

  1. A) the CPA and management agree that procedures will be applied to all accounts and circumstances.
  2. B) the CPA and management agree that procedures will not be applied to all accounts and circumstances.
  3. C) the CPA, the responsible party making the assertions, and the specific persons who are the intended users of the CPA’s report agree to all the procedures the CPA will perform.
  4. D) the CPA, the responsible party making the assertions, and the specific persons who are the intended users of the CPA’s report agree that the CPA will apply his judgment to determine the procedures to be performed.

Answer:  C

Terms:  Agreed-upon procedures engagement

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

14) When a CPA performs an examination engagement under the attestation standards, the amount of evidence gathered is ________ and the level of assurance is ________.

  1. A) extensive; varying
  2. B) significant; high
  3. C) extensive; high
  4. D) significant; moderate

Answer:  C

Terms:  Agreed-upon procedures engagement

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

15) When performing an attestation engagement, a CPA is required to adhere to the Statements on Standards for Attestation Engagements. Describe below the Standards of Field Work for attestation engagements.

Answer:

  1. The practitioner must adequately plan the work and must properly supervise any assistants.
  2. The practitioner must obtain sufficient evidence to provide a reasonable basis for the conclusion that is expressed in the report.

Terms:  Attestation engagement; Statements on Standards for Attestation Engagements

Diff:  Easy

Objective:  LO 25-3

AACSB:  Reflective thinking

16) Statements on Standards for Attestation Engagements (SSAEs ) are issued by the Auditing Standards Board of the AICPA.

Answer:  TRUE

Terms:  SSAEs

Diff:  Easy

Objective:  LO 25-3

AACSB:  Reflective thinking

 

17) Auditors of the financial statements of public companies must follow the guidelines in the SSAEs.

Answer:  FALSE

Terms:  Attestation engagement; Statements on Standards for Attestation Engagements

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

18) The use of positive assurance is appropriate in a review attestation report.

Answer:  FALSE

Terms:  Positive assurance; Review reports

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

19) Of the three types of attestation engagements, examination engagements provide a higher level of assurance than agreed-upon procedures engagements but less than review engagements.

Answer:  FALSE

Terms:  Attestation engagements; Examination engagements; Agree-upon procedure engagements

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

20) Examination attestation engagements result in a conclusion that is in a positive form, whereas review attestation engagements result in a conclusion in the form of a negative assurance.

Answer:  TRUE

Terms:  Examination attestation engagements; Review attestation engagements

Diff:  Moderate

Objective:  LO 25-3

AACSB:  Reflective thinking

 

25.4   Learning Objective 25-4

 

1) Which of the following services is performed under the attestation standards?

  1. A)
WebTrust SysTrust
Yes Yes

 

  1. B)
WebTrust SysTrust
No No

 

  1. C)
WebTrust SysTrust
Yes No

 

  1. D)
WebTrust SysTrust
No Yes

 

Answer:  C

Terms:  Services performed under attestation standards

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

 

2) The WebTrust service requires that a CPA update its testing of the e-commerce aspects of an entity’s website at least every

  1. A) ninety days.
  2. B) month.
  3. C) six months.
  4. D) twelve months.

Answer:  D

Terms:  WebTrust; Update testing of e-commerce aspects

Diff:  Easy

Objective:  LO 25-4

AACSB:  Reflective thinking

 

 

3) In a WebTrust attestation engagement the client engages a CPA to provide what level of assurance that the company’s website complies with Trust Services principles?

  1. A) absolute
  2. B) reasonable
  3. C) limited
  4. D) moderate

Answer:  B

Terms:  WebTrust

Diff:  Easy

Objective:  LO 25-4

AACSB:  Reflective thinking

4) The service auditor’s Type 2 report contains

  1. A) an opinion on the reasonableness of the financial statements.
  2. B) the two opinions about the description and suitability of the design of controls that are issued in a Type 1 report plus an additional opinion about the operating effectiveness of controls throughout the period.
  3. C) an opinion only on the operating effectiveness of the controls.
  4. D) an opinion on the service company’s website.

Answer:  B

Terms:  Report on controls at service organizations

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

 

5) What type of SOC report is intended to meet the needs of entities that use service organizations and their auditors, who are responsible for understanding internal controls over financial reporting at service organizations?

  1. A) SOC 1 report
  2. B) SOC 2 report
  3. C) SOC 3 report
  4. D) none of the above

Answer:  A

Terms:  Report on controls at service organizations

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

 

 

6) What type of SOC report is intended to meet the needs of a broad range of users who need information and assurance about controls at s service organization that affect the security, availability, and processing integrity of the systems the service organization uses to process users’ data and the confidentiality and privacy of the information processed by these systems?

  1. A) SOC 1 report
  2. B) SOC 2 report
  3. C) SOC 3 report
  4. D) none of the above

Answer:  B

Terms:  Report on controls at service organizations

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

 

7) Which of the following is not one of the five Trust Services principles?

  1. A) security
  2. B) confidentiality
  3. C) completeness
  4. D) availability

Answer:  C

Terms:  Trust Services principles

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

8) Who developed the WebTrust service? Briefly explain this service.

Answer:  WebTrust was developed jointly by the AICPA and CPA Canada. In a WebTrust engagement, a client engages a CPA to provide reasonable assurance that the client’s web site complies with certain Trust Services principles and criteria for one or more aspects of e-commerce activities. A site that meets the Trust Service principles is eligible to display the WebTrust electronic seal on its transaction or order page.

Terms:  WebTrust

Diff:  Easy

Objective:  LO 25-4

AACSB:  Reflective thinking

 

 

9) Briefly describe each of the five Trust Services principles.

Answer:  The five Trust Services principles are:

 

  1. Security — security practices ensuring that the system is protected against unauthorized access (both physical and logical)
  2. Availability — availability practices ensuring that the system is available for operation and use as committed or agreed
  3. Processing integrity — processing integrity, ensuring that the system processing is complete, accurate, timely, and authorized
  4. Confidentiality — confidentiality practices, ensuring that information designated as confidential is protected as committed or agreed
  5. Privacy — online privacy practices, ensuring that personal information obtained as a result of e-commerce is collected, used, disclosed, and retained as committed or agreed

Terms:  Trust Services principles

Diff:  Challenging

Objective:  LO 25-4

AACSB:  Reflective thinking

 

10) WebTrust services are performed under the direction of the SSARS.

Answer:  FALSE

Terms:  WebTrust services; SSARS

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

 

11) The AICPA has discontinued the SysTrust seal program.

Answer:  TRUE

Terms:  Systrust services

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

 

12) There are five Trust Service principles, including security and viability.

Answer:  FALSE

Terms:  Trust Services principles

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

13) SOC 3 reports are prepared using the Trust Services principles.

Answer:  TRUE

Terms:  Trust Services principles

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

 

 

14) The guidance for service auditors has been moved to the attestation standards.

Answer:  TRUE

Terms:  Report on controls at service organizations

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

 

15) In a Type 2 engagement, the service auditor performs tests of the operating effectiveness of the controls, but does not have to perform any of the procedures performed in a Type 1 engagement.

Answer:  FALSE

Terms:  Report on controls at service organizations

Diff:  Moderate

Objective:  LO 25-4

AACSB:  Reflective thinking

 

25.5   Learning Objective 25-5

 

1) As a CPA you have been asked to examine an entity’s financial projections. Acceptance of the engagement would be appropriate if distribution is limited to

  1. A) stockholders of record as of the date of the report.
  2. B) potential investors and creditors by posting on the company’s website.
  3. C) general public by posting on the company’s website.
  4. D) a financial institution for which the company is negotiating a loan.

Answer:  D

Terms:  Examine financial projections; Distribution limited to

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

 

2) Which of the following is a type of prospective financial statement as defined by the AICPA attestation standards?

  1. A)
Forecasts Projections Earnings estimates
No No Yes

 

  1. B)
Forecasts Projections Earnings estimates
No Yes No

 

  1. C)
Forecasts Projections Earnings estimates
Yes Yes No

 

  1. D)
Forecasts Projections Earnings estimates
Yes No Yes

 

Answer:  C

Terms:  General types of prospective financial statements

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

 

 

3) Which are prospective financial statements that present an entity’s expected financial position, results of operations, and cash flows, to the best of the responsible party’s knowledge and belief?

  1. A)
Forecasts Projections
Yes Yes

 

  1. B)
Forecasts Projections
No No

 

  1. C)
Forecasts Projections
Yes No

 

  1. D)
Forecasts Projections
No Yes

 

Answer:  C

Terms:  Prospective financial statements

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

 

4) Which are prospective financial statements that present an entity’s financial position, results of operations, and cash flows, to the best of the responsible party’s knowledge and belief, given one or more hypothetical assumptions?

  1. A)
Forecasts Projections
Yes Yes

 

  1. B)
Forecasts Projections
No No

 

  1. C)
Forecasts Projections
Yes No

 

  1. D)
Forecasts Projections
No Yes

 

Answer:  D

Terms:  Prospective financial statements; one or more hypothetical assumptions

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

 

5) Professional standards prohibit which one of the following types of engagements for prospective financial statements from being undertaken?

  1. A) a compilation
  2. B) a review
  3. C) an examination
  4. D) an agreed-upon procedures engagement

Answer:  B

Terms:  Professional standards prohibit engagement for prospective financial statements

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

 

6) General use statements are prepared for use by

  1. A) known contractual parties.
  2. B) any third party.
  3. C) regulators.
  4. D) internal auditors.

Answer:  B

Terms:  General use statements

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

 

7) Which of the following statements regarding prospective financial statements is most correct?

  1. A) CPAs are not attesting to the accuracy of the prospective financial statements.
  2. B) CPAs are attesting to the accuracy of the prospective financial statements.
  3. C) CPAs are performing a review on the company’s assumptions and hypotheticals that underlie the prospective financial statements.
  4. D) CPAs are performing a review on the achievability of the prospective financial statements.

Answer:  A

Terms:  Examination of prospective financial statements

Diff:  Challenging

Objective:  LO 25-5

AACSB:  Reflective thinking

 

8) What is the best reason that standards prohibit accepting an engagement on a projection for general use?

  1. A) The CPA’s procedures would violate SSARS.
  2. B) Reports on projections are not well understood by the general public.
  3. C) Underlying hypothetical assumptions are difficult to interpret without obtaining additional information.
  4. D) The CPA is not qualified to report on the use of GAAP in the projected financial statement.

Answer:  C

Terms:  Standards for engagement on projection for general use

Diff:  Challenging

Objective:  LO 25-5

AACSB:  Reflective thinking

 

9) Which of the following is not an element of the examination of prospective financial statements?

  1. A) evaluating the preparation of the prospective financial statements
  2. B) understanding internal controls
  3. C) evaluating the support underlying the assumptions
  4. D) issuing an examination report

Answer:  B

Terms:  Element of examining prospective financial statements

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

 

 

10) Which of the following statements is not correct?

  1. A) Forecasts can be provided for general use.
  2. B) Forecasts can be provided for limited use.
  3. C) Projections can be provided for general use.
  4. D) Projections can be provided for limited use.

Answer:  C

Terms:  Prospective financial statements; General use and limited use

Diff:  Challenging

Objective:  LO 25-5

AACSB:  Reflective thinking

11) Attestation standards allow a CPA to perform all but which of the following services for a forecast or projection?

  1. A) compilation
  2. B) review
  3. C) examination
  4. D) agreed-upon procedures

Answer:  B

Terms:  Attestation standards; Services for a forecast or projection

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

 

12) Define forecast and projection.

Answer:  Forecasts are prospective financial statements that present an entity’s expected financial position, results of operations, and cash flows, to the best of the responsible party’s knowledge and belief.

Projections are prospective financial statements that present an entity’s financial position, results of operations, and cash flows, to the best of the responsible party’s knowledge and belief, given one or more hypothetical assumptions.

Terms:  Forecast and projection

Diff:  Easy

Objective:  LO 25-5

AACSB:  Reflective thinking

 

13) The examination of prospective financial statements contains four elements that comprise the examination. List the four elements below.

Answer:

  1. Evaluate the preparation of the prospective financial statements.
  2. Evaluate the support underlying the assumptions.
  3. Evaluate the presentation of the prospective financial statements for conformity with AICPA presentation guidelines.
  4. Issue the examination report.

Terms:  Examination of prospective financial statements

Diff:  Easy

Objective:  LO 25-5

AACSB:  Reflective thinking

 

14) In an examination engagement for prospective financial statements, the CPA obtains satisfaction as to the completeness and reasonableness of all the assumptions.

Answer:  TRUE

Terms:  Professional standards for performing engagements to review forecasts or projections

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

 

15) Current professional standards prohibit accountants from performing engagements to review forecasts or projections.

Answer:  TRUE

Terms:  Professional standards for performing engagements to review forecasts or projections

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

16) Considerable guidance is provided by the AICPA Guide for Prospective Financial Statements which includes criteria against which an attestation engagement can be compared.

Answer:  TRUE

Terms:  AICPA Guide for Prospective Financial Statements

Diff:  Moderate

Objective:  LO 25-5

AACSB:  Reflective thinking

 

25.6   Learning Objective 25-6

 

1) Which of the following is not an accurate statement regarding agreed-upon procedures engagements?

  1. A) These engagements are also known as procedures and findings engagements.
  2. B) A report for such an engagement describes the findings resulting from the procedures, but cannot describe the procedures agreed upon.
  3. C) All agreed-upon procedure engagements are now under the scope of attestation standards.
  4. D) Agreed-upon procedures engagements appeal to CPAs because management, or a third-party user, specifies the procedures they want done.

Answer:  B

Terms:  Agreed-upon procedures to prospective financial statements

Diff:  Moderate

Objective:  LO 25-6

AACSB:  Reflective thinking

 

 

2) An agreed-upon procedures engagement cannot be undertaken for a federal government agency.

Answer:  FALSE

Terms:  Agreed-upon procedures engagement

Diff:  Easy

Objective:  LO 25-6

AACSB:  Reflective thinking

 

25.7   Learning Objective 25-7

 

1) One of the bases other than GAAP or IFRS is the Financial reporting framework for small- and medium-sized businesses. This basis

  1. A) has not yet been approved by the AICPA.
  2. B) is the same as the income tax basis.
  3. C) draws upon a blend of traditional accounting principles and accrual income tax methods of accounting.
  4. D) must be used by a business with sales under $1 million.

Answer:  C

Terms:  Other comprehensive basis of accounting

Diff:  Easy

Objective:  LO 25-7

AACSB:  Reflective thinking

2) Clients occasionally enter into loan agreements that require them to provide the ________ with a report from a CPA about the existence or nonexistence of some condition.

  1. A) underwriters of securities
  2. B) audit committee
  3. C) lender
  4. D) Securities and Exchange Commission

Answer:  C

Terms:  Debt compliance letters

Diff:  Moderate

Objective:  LO 25-7

AACSB:  Reflective thinking

 

3) When CPAs do audits for specified elements, accounts, or items,

  1. A) materiality is defined in terms of the overall financial statements.
  2. B) materiality is defined in terms of the elements, accounts, or items being audited.
  3. C) auditors do not need to extend their audit efforts to include other elements, accounts, or items that are interrelated with those being audited.
  4. D) the authority for auditing specified elements, accounts, or items is in the review and compilation standards.

Answer:  B

Terms:  Other audits or limited assurance engagements

Diff:  Moderate

Objective:  LO 25-7

AACSB:  Reflective thinking

 

4) A CPA who has been engaged to audit financial statements that were prepared on a cash basis

  1. A) must ascertain that there is proper disclosure of the fact that the cash basis has been used.
  2. B) may not be associated with such statements which are not in accordance with generally accepted accounting principles.
  3. C) must render a qualified report explaining the departure from generally accepted accounting principles in the opinion paragraph.
  4. D) must restate the financial statements on an accrual basis and then render the standard (short-form) report.

Answer:  A

Terms:  Engaged to audit financial statements prepared on a cash basis

Diff:  Moderate

Objective:  LO 25-7

AACSB:  Reflective thinking

5) The engagement and report on debt compliance letters should be limited to compliance matters that the auditor is qualified to evaluate. Which of the following engagements would be inappropriate for the CPA to attempt to evaluate?

  1. A) determining whether the client has properly restricted its business activities to the requirements of an agreement
  2. B) determining whether principal and interest payments were made when due
  3. C) determining whether the proper limitations were maintained on dividends, working capital, and debt ratios
  4. D) determining whether the accounting records were adequate for conducting an ordinary audit

Answer:  A

Terms:  Engagement and report on debt compliance letters

Diff:  Challenging

Objective:  LO 25-7

AACSB:  Analytic thinking

 

6) State three types of assurance services that fall within the auditing standards but are not audits, reviews, or compilations of financial statements in accordance with GAAP.

Answer:

  • other comprehensive basis of accounting.
  • specified elements, accounts, or items.
  • debt compliance letters and similar reports.

Terms:  Types of assurance services which fall within auditing standards but are not audits, reviews, or compilations

Diff:  Moderate

Objective:  LO 25-7

AACSB:  Reflective thinking

 

 

7) Auditors frequently audit statements prepared on bases other than GAAP. Discuss four commonly used bases other than GAAP.

Answer:

  • Cash or modified cash basis. With the cash basis, only cash receipts and disbursements are recorded; there are no accruals. Under the modified cash basis, the cash basis is followed except for certain items, such as fixed assets and depreciation.
  • Basis used to comply with the requirements of a regulatory agency. This includes the uniform system of accounts required of railroads, utilities, and some insurance companies.
  • Income tax basis. The same measurement rules used for filing tax returns are often used for financial statement preparation, even though this is not in accordance with generally accepted accounting principles (GAAP) or IFRS.
  • Financial reporting framework for small-and medium-sized businesses. A framework developed by the AICPA that is a self-contained framework not based on accounting principles generally accepted in the United States of America (GAAP). The framework draws upon a blend of traditional accounting principles and accrual income tax methods of accounting.
  • A definite set of criteria having substantial support. For example, the price-level basis of accounting could be applied to all material items in the financial statements.

Terms:  Audit statements prepared on bases other than GAAP

Diff:  Moderate

Objective:  LO 25-7

AACSB:  Reflective thinking

8) A primary concern in reporting on a comprehensive basis is to make sure that the statements clearly indicate that they are prepared on a basis other than GAAP.

Answer:  TRUE

Terms:  Reporting on a comprehensive basis

Diff:  Easy

Objective:  LO 25-7

AACSB:  Reflective thinking

 

9) When issuing a debt compliance letter, the auditor’s opinion should be in the form of a negative assurance.

Answer:  TRUE

Terms:  Debt compliance letter; Negative assurance

Diff:  Moderate

Objective:  LO 25-7

AACSB:  Reflective thinking

 

10) Auditors should provide debt compliance letters only for clients for whom the auditor has done an audit of the overall financial statements.

Answer:  TRUE

Terms:  Debt compliance letters

Diff:  Moderate

Objective:  LO 25-7

AACSB:  Reflective thinking

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