Chapter 1 The Demand for Audit and Other Assurance Services

1) The Sarbanes-Oxley Act applies to which of the following companies?

A) All companies.
B) Privately held companies.
C) Public companies.
D) All public companies and privately held companies with assets greater than $500 million.

2) The criteria by which an auditor evaluates the information under audit may vary with the information
being audited.
A) True
B) False

3) The criteria used by an external auditor to evaluate published financial statements are known as
generally accepted auditing standards.
A) True
B) False

4) The Sarbanes-Oxley Act establishes standards related to the audits of privately held companies.
A) True
B) False

5) Recording, classifying, and summarizing economic events in a logical manner for the purpose of
providing financial information for decision making is commonly called:
A) finance.
B) auditing.
C) accounting.
D) economics.

6) Which department provides quantitative information in order for management and others to make
decisions?
A) management information systems.
B) auditing.
C) finance.
D) accounting.

7) In "auditing" financial accounting data, the primary concern is with:

A) determining whether recorded information properly reflects the economic events that occurred
during
the accounting period.
B) determining if fraud has occurred.
C)determining if taxable income has been calculated correctly.
D) analyzing the financial information to be sure that it complies with government requirements.

8) _______ risk reflects the possibility that the information upon which the business decision was made
was inaccurate.
A) Client acceptance
B) Information
C) Business
D) Control

9) Explain what is meant by information risk, and list the four causes of this risk.
Answer: Information risk reflects the possibility that the information upon which the business risk
decision was made was inaccurate. Four causes of information risk are:
 remoteness of information,
 biases and motives of the provider,
 voluminous data, and
 complex exchange transactions.

10) In the audit of historical financial statements, what accounting criteria is most common?
A) Regulatory accounting principles.
B) International financial reporting standards. (International)
C) Generally accepted accounting principles. (U.S.)
D) B and C
E) All of the above.

11) The Sarbanes-Oxley Act prohibits a CPA firm that audits a public company from providing which of
the following types of services to that company?
A) Reviews of quarterly financial statements.
B) Preparation of corporate tax returns.
C) Most consulting services.
D) Tax services.

12) One objective of an operational audit is to:

A) determine whether the financial statements fairly present the entity's operations.
B) evaluate the feasibility of attaining the entity's operational objectives.
C) make recommendations for improving performance.
D) report on the entity's relative success in attaining profit maximization.

13) An examination of part of an organization's procedures and methods for the purpose of evaluating
efficiency and effectiveness is what type of audit?
A) Operational audit.
B) Compliance audit.
C) Financial statement audit.
D) Production audit.

14) An audit to determine whether an entity is following specific procedures or rules set down by some
higher authority is classified as a(n):
A) audit of financial statements.
B) compliance audit
C) operational audit.
D) production audit.

15) Which one of the following is more difficult to evaluate objectively?

A) Presentation of financial statements in accordance with generally accepted accounting principles.
B) Compliance with government regulations.
C) Efficiency and effectiveness of operations.
D) All three of the above are equally difficult.

16) The primary purpose of a compliance audit is to determine whether the financial statements are
prepared in compliance with generally accepted accounting principles.
A) True
B) False

17) Results of compliance audits are typically reported to someone within the organizational unit being
audited rather than to a broad spectrum of outside users.
A) True
B) False

18) Discuss the differences and similarities between the roles of accountants and auditors.What
additional expertise must an auditor possess beyond that of an accountant?
Auditor must know the auditing and accounting rules

5) Discuss the similarities and differences between financial statement audits,operational audits,and
compliance audits.Give an example of each type.
(Slide 15,16,17) Auditor gives his opinion based on specific criteria

19) Name the Big Four international audit firms and give a brief history of each.
KPNG, PWC, Deloitte, Ernst & Young

Case:

Auditor responsibility. Four friends who are auditing students have a discussion. Jon
says that the primary responsibility for the adequacy of disclosure in the financial
statements and footnotes rests with the auditor in charge of the audit field work. Mai-ling
says that the partner in charge of the engagement has the primary responsibility. Abdul
says the staff person who drafts the statements and footnotes has the primary
responsibility.Yolanda contends that it is the client's responsibility.

Required:
A. Which student is correct and why?
Clients responsibility/CEO
 Chapter 2
The CPA Profession

Practice Exercises:

1) The legal right to perform audits is granted to a CPA firm by regulation of:
A) each state.
B) the Financial Accounting Standards Board (FASB).
C) the American Institute of Certified Public Accountants (AICPA).
D) the Audit Standards Board.

2) Many small/local accounting firms do not perform audits as their primary services to their clients
include accounting and tax.
A) True
B) False
3) The organization that is responsible for providing oversight for auditors of public companies is called
the__________.
A) Auditing Standards Board.
B) American Institute of Certified Public Accountants.
C) Public Oversight Board.
D) Public Company Accounting Oversight Board.

4) The Public Company Accounting Oversight Board:

A) perform inspections of the quality controls at audit firms that audit public companies.
B) establish auditing standards that must be followed by CPAs on all audits.
C) oversee auditors of private companies.
D) perform any of the above functions.

5) Assume the Public Company Accounting Oversight Board(PCAOB)identifies a violation during its
inspection of a registered accounting firm.The PCAOB:
A)
can enforce disciplinary action report the matter to the suspend the license to practice
against the accounting firm Securities and Exchange of the CPA guilty of the
Commission violation

Yes Yes Yes

B)
can enforce disciplinary action report the matter to the suspend the license to practice
against the accounting firm Securities and Exchange of the CPA guilty of the
Commission violation

Yes Yes No

C)
can enforce disciplinary action report the matter to the suspend the license to practice
against the accounting firm Securities and Exchange of the CPA guilty of the
Commission violation
 Yes No No

D)
can enforce disciplinary action report the matter to the suspend the license to practice
against the accounting firm Securities and Exchange of the CPA guilty of the
Commission violation

No No No

6) The AICPA has authority to establish standards and rules in all except which of the following areas?
A) Auditing standards applicable to financial statements of private companies
B) Compilation and review standards
C) Professional conduct
D) Auditing standards applicable to financial statements of private and public companies

7) Which of the following are audit standards used in professional practice by audit firms?
A)
International Standards U.S. Generally Accepted PCAOB Auditing Standards
on Auditing Auditing Standards

Yes No No

B)
International Standards U.S. Generally Accepted PCAOB Auditing Standards
on Auditing Auditing Standards

Yes Yes No

C)
International Standards U.S. Generally Accepted PCAOB Auditing Standards
on Auditing Auditing Standards

Yes Yes Yes

D)
International Standards U.S. Generally Accepted PCAOB Auditing Standards
on Auditing Auditing Standards

No Yes Yes

7) If an auditor of a public company cannot find guidance issued by the PCAOB on a particular audit
matter, the auditor should generally seek guidance from which of the following sources?
A) Statements on Auditing Standards - SAS
B) Statements on Standards for Accounting and Review Services
C) Regulations issued by the Securities and Exchange Commission
D) The AICPA Code of Professional Conduct
8) Which of the following is not one of the responsibilities of an auditor under the principles underlying
an audit?
A) Possess appropriate competence and capabilities.
B) Comply with ethical requirements.
C) Plan work and supervise assistants.
D) Maintain professional skepticism and exercise professional judgment.

9) To obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement, the auditor must fulfill several performance responsibilities, including:
A) verifying that all audit work is performed by a CPA with a minimum of three years experience.
B) obtaining sufficient, appropriate audit evidence.
C) exercising professional judgment.
D) providing an opinion one the financial statements.

10) In order to properly plan and perform an audit, an important fact for both the auditor and the client
to understand is that:
A) the internal control policies and procedures are developed by the auditors.
B) the purpose of an audit is to prevent fraud.
C) management is responsible for the preparation of the financial statements.
D) management can restrict the auditor's access to important information relevant to the financial
statements.

11) Hansen Corporation's stock is listed on a national stock exchange and registered with the Securities
and Exchange Commission.Hansen's management hires a CPA to perform an independent audit of
Hansen's financial statements.The primary objective of this audit is to provide assurance to the:
A) investors in Hansen Corporation's stock.
B) stock exchange.
C) Securities and Exchange Commission.
D) management of Hansen Corporation.

12) Generally Accepted Auditing Standards (GAAS)and Statements on Auditing Standards (SAS)should
be looked upon by practitioners as:
A) ideals to work towards, but which are not achievable.
B) maximum standards that denote excellent work.
C) minimum standards of performance that must be achieved on each audit engagement.
D) benchmarks to be used on all audits, reviews, and compilations.

13) Distinguish between generally accepted auditing standards (GAAS)and generally accepted accounting
principles (GAAP). What professional organization establishes GAAS? What professional
organization establishes GAAP?
GAAS rules are applied for audit of Financial Statements - prepared by private company and issued –
issued by AICPA
GAAP rules are applied to prepare Financial Statements – issued by FIAB

14) List and describe the three factors that influence the organizational structure of all CPA firms. What
are the most common forms of CPA firm organization?
Ch 2, slide 6,7

15) The Sarbanes-Oxley Act established the Public Company Accounting Oversight Board (PCAO8).
What are the PCAOB's primary functions?
- Provide oversight to the auditor
- Establish auditing control standards
- Inspection of audit firms

16) Discuss the purpose of the Securities and Exchange Commission and its influence on setting generally
accepted accounting principles.
- Protecting investors by providing reliable information
- Security and Exchange Commission (SEC) provide guidelines to FASB for setting GAAP
- FASB gives huge importance to the opinion of SEC for establishing the standards.

Case:

AUDITORS OPINION ON THE OCCURRENCE OF FRAUD

Sundback, CGR, is the auditor for Upseerin Manufacturing, a privately owned company in Espoo,
Finland, which has a June 30 fiscal year. Upseerin arranged for a substantial bank loan which was
dependent upon the bank receiving, by September 30, audited financial statements which showed a
current ratio of at least 2 to 1. On September 25, just before the audit report was to be issued, Sundback
received an anonymous letter on Upseerin's stationery indicating that a 5-year lease by Upseerin, as
lessee, of a factory building which was accounted for in the financial statements as an operating lease was
in fact a capital lease. The letter stated that there was a secret written agreement with the lessor modifying
the lease and creating a capital lease.

Sundback confronted the president of Upseerin who admitted that a secret agreement existed but said it
was necessary to treat the lease as an operating lease to meet the current ratio requirement of the pending
loan and that nobody would ever discover the secret agreement with the lessor. The president said that if
Sundback did not issue her report by September 30, Upseerin would sue Sundback for substantial
damages which would result from not getting the loan. Under this pressure and because the work papers
contained a copy of the 5-year lease agreement which supported the operating lease treatment, Sundback
issued her report with an unqualified opinion on September 29

In spite of the fact that the loan was received, Upseerin went bankrupt within 2 years. The
bank is suing Sundback to recover its losses on the loan and the lessor is suing Sundback to recover
uncollected rents.
Required:
1- Is Sundback liable to the bank? Absolutely responsible. If the bank has taken decision based on
Audited report to grant loan to Upseerin
2- Is Sundback liable to the lessor? Agreement was not based on the report

Chapter 3
 Practice Exercises

1) An audit of historical financial statements most commonly includes the:

A) balance sheet, statement of retained earnings, and the statement of cash flows.
B) income statement, the statement of cash flows, and the statement of net working capital.
C) statement of cash flows, balance sheet, and the statement of retained earnings.
D) balance sheet, income statement, and the statement of cash flows

2) Auditing standards requires that the audit report must be titled and that the title must:
A) include the word "independent."
B) indicate if the auditor is a CPA.
C)indicate if the auditor is a proprietorship, partnership, or incorporated.
D) indicate the type of audit opinion issued.

3) The audit report date on a standard unqualified report indicates:

A) the last day of the fiscal period.
B) the date on which the financial statements were filed with the Securities and Exchange Commission
C) the last date on which users may institute a lawsuit against either client or auditor.
D) the last day of the auditor's responsibility for the review of significant events that occurred subsequent
to the date of the financial statements.

4) If an auditor performs an audit of a public company, the scope paragraph should make reference to
which standards?
A) GAAP.
B) GAAS.
C) Standards issued by the PCAOB (U.S.).
D) International Audit Standards.

5) The introductory paragraph of the standard audit report states that the financial statements are:
A) the responsibility of the auditor.
B) the responsibility of management.
C) the joint responsibility of management and the auditor.
D) none of the above.

6) The introductory paragraph of the standard audit report states that the auditor is:
A) responsible for the financial statements and the opinion on them.
B) responsible for the financial statements
C) responsible for the opinion on the financial statements.
D) jointly responsible for the financial statements with management.

7) The standard unqualified audit report:

A) is sometimes called a clean opinion.
B) can be issued only with an explanatory paragraph.
C) can be issued if only a balance sheet and income statement are included in the financial statements.
D) is sometimes called a disclaimer report.

8) The standard unqualified audit report for public entities includes the following three paragraphs:
A) introductory, scope and management's responsibility
B) materiality, scope and report.
C) introductory, scope and opinion.
D) scope, fieldwork and conclusion.
9) Auditing standards for public companies are established by the:
A) SEC.
B) FASB
C) PCAOB.
D) IRS.

10) Which of the following is least likely to cause uncertainty about the ability of an entity to continue as
a going concern?
A) The entity is suing a competitor for a minor patent infringement.
B) The entity has lost a major customer.
C) The entity has significant recurring operating losses.
D) The entity has working capital deficiencies.

11) When a company's financial statements contain a departure from GAAP with which the auditor
concurs, the departure should be explained in:
A) the scope paragraph.
B) an explanatory paragraph that appears before the opinion paragraph.
C) the opinion paragraph.
D) an explanatory paragraph after the opinion paragraph.

12) A company has changed its method of inventory valuation from an unacceptable one to one in
conformity with generally accepted accounting principles. The auditor's report on the financial
statements of the year of the change should include:
A) no reference to consistency.
B) a reference to a prior period adjustment in the opinion paragraph.
C) an explanatory paragraph that justifies the change and explains the impact of the change on reported
net income.
D) an explanatory paragraph explaining the change.

13) As a result of management's refusal to permit the auditor to physically examine inventory. The
auditor must depart from the unqualified audit report because:
A) the financial statements have not been prepared in accordance with GAAP.
B) the scope of the audit has been restricted by circumstances beyond either the client's or auditor's
control.
C) the financial statements have not been audited in accordance with GAAS.
D) the scope of the audit has been restricted.

14) An adverse opinion is issued when the auditor believes:

A) some parts of the financial statements are materially misstated or misleading.
d the financial statements would be found to be materially misstated if an investigation were performed.
B) the financial statements would be found to be materially misstated if an investigation were performed
C) the auditor is not independent.
D) the overall financial statements are so materially misstated that they do not present fairly the financial
position or results of operations and cash flows in conformity with GAAP

15) When there is a justified departure from GAAP which is considered material, the auditor should
a(n):
A) standard unqualified audit report

B) disclaimer of opinion.
C) unqualified audit report with an explanatory paragraph.
D) adverse opinion.

16) A misstatement in the financial statements can be considered material if knowledge of the
misstatement will affect a decision of:
A) the PCAOB.
B) a reasonable user of the financial statements.
C) an accountant.
D) the SEC.

17) The dollar amount of some misstatements cannot be accurately measured. For example, if the client
were unwilling to disclose an existing lawsuit, the auditor must estimate the likely effect on:
A) net income.
B) users of the financial statements.
C) the auditor's exposure to lawsuits.
D) management’s future decisions.

18) Subsequent to the close of Spacely Sprockets fiscal year ending October 31, 2012, major a debtor has
declared bankruptcy due to a series of events. The receivable is significantly material in relation to the
financial statements, and recovery is doubtful. The debtor had confirmed the full amount due to Spacely
Sprocket at the balance sheet date. Because the account was confirmed at the balance sheet date, Spacely
refuses to disclose any information in relation to this subsequent event. The CPA believes that all other
accounts were stated fairly at the balance sheet date. In addition, Spacely changed their method of
inventory valuation from FIFO to LIFO. This change was disclosed in Note X to the financial statements.
Accordingly, what type of opinion should be expressed?
A) Unqualified with an explanatory paragraph.
B) Qualified due to a GAAP departure.
C)Qualified due to a scope limitation.
D) A combination of B and C.

19) The following is a portion of an adverse audit report issued fora public company. (Note: A separate
report was issued on the effectiveness of internal control over financial reporting.)

Independent Auditor's Report

To the shareholders of Wallace Corporation

We have audited the accompanying balance sheet of Wallace Corporation as of December 31, 2012, and
the related statements of income, retained earnings, and cash flows for the year then ended. These
financial statements are the responsibility of the company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
we conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit includes
examining on a test basis, evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.

The company has excluded from property and debt in the accompanying balance sheet certain lease
obligations that, in our opinion, should be capitalized in order to conform with generally accepted
accounting principles. If these lease obligations were capitalized, property would be increased by
$14,500,000, long-term debt by $13,200,000, and retained earnings by $1,300,000 as of December 31,
2012, and net income and earnings per share would be increased by $1,300,000 and $2.25, respectively,
for the year then ended.

Required:

Complete the above adverse audit report by preparing the opinion paragraph. Do not date or sign the
report.
Adverse

20) The following is a portion of a qualified scope and opinion report due to a scope restriction. (Note: A
separate report was issued on the effectiveness of internal control over financial reporting.)

Independent Auditor's Report

To the shareholders of Fast Times Corporation

We have audited the accompanying balance sheet of Fast Times Corporation as of September 30, 2012,
and the related statements of income, retained earnings, and cash flows for the year then ended, and the
related notes to the financial statements.

Basis for Qualified Opinion

We were unable to obtain audited financial statements supporting the company's investment in a foreign
affiliate stated at $1,040,000, or its equity in earnings of that affiliate of $501,000, which is included in
net income, as described in Note 14 to the financial statements. Because of the nature of the company's
records, we were unable to satisfy ourselves as to the carrying value of the investment or the equity in its
earnings by means of other auditing procedures.

Required:

Prepare the opinion paragraph for the above audit report. Do not date or sign the report.
Qualified

21) Describe the standard unqualified report to be issued for an audit of a private company. Begin by,
specifying the seven parts of the report, and then discuss the contents of each part.
(Slide 3,4)

22) In certain circumstances, an auditor will issue modified unqualified report. Discuss each of the five
Circumstances when an auditor would issue an unqualified report with an explanatory paragraph or
modified wording.
(Slide 14)

25) There are three conditions necessitating a departure from an unqualified audit report. Name, discuss
and state the appropriate audit report for each of these three conditions.
(Slide-20)

24) Discuss how materiality affects audit reporting decisions.

(Slide 28, 29)
Chapter 8
 Audit Planning and Analytical Procedures

1) Discuss the factors an auditor should consider before accepting a company as an audit client.
The client’s type of industry, is the client independent, Financial Stability of the firm, management
honesty and integrity, relationship with attorney and previous audit

2) Discuss the essential activities involved in the initial planning of an audit.

Ch.8 Slide 7 and the explanation

3) Discuss the required communications between predecessor and successor auditors.

The new auditor can ask and discuss about the company. 1) The new auditor should initiate the
communication 2) The predecessor should take the permission of the client before discussing to the new
Auditor
4) Define the term "related party" and discuss why an auditor should identify the client's related parties
early in the audit.
Any party that can influence the business or vice versa, Major shareholders or any major suppliers and
bankers
5) Discuss the four primary purposes of analytical procedures performed during the planning phase of an
audit.
1) To understand the client industry 2) Determine the going concern of the firm 3) To indicate some area
of misstatement or risk. 4) To determine the level test, you will know what level of test you have to apply

Audits of Internal Control and Control Risk

1)Describe each of the three broad objectives management typically has for internal control. With which
of these objectives is the auditor primarily concerned?
1) Financial Statements should be reliable 2) improving efficiency of your operations 3) Compliance with
law and regulations

2) Management's identification and analysis of risk is an ongoing process and is a critical component of
effective internal control. An important first step is for management to identify factors that may increase
risk. Identify at least five factors, observable by management, which may lead to increased risk in a
typical business organization.
1) Quality of human resource 2) Failure to achieve objectives 3) New Information Technology 4)
Company has its operations at different locations

3) Separation of duties is essential in preventing errors and intentional misstatements on the financial
statements. List below the four general guidelines.
1) The physical separation of custody of asset from accounting of asset 2) separation of authorization of
transaction from custody of asset 3) separation of operational responsibility from the book keeping
responsibility 4) separation of IT from user department

4) The internal control framework developed by COSO includes five so-called "components" of internal
control. Discuss each of these five components.
Ch10 slide9

6) You are the audit manager for a new audit client. Your staff auditors are unsure of what constitutes a
control deficiency. Discuss the definition of control deficiency. In your response include at least two
examples of control deficiencies.
Control deficiency exists when design of control doesn’t allow the employee to detect fraud on time.
Example1: You check inventory every one month, at the end of the month when you went to check
inventory physically, the record shows 10,000 units but physically there are 9,000 units. After
investigating, you found out that the 1,000 units were spoilt and destroyed because of bad temperature.
Example2: Production manager who is the in charge of the who production department, after 6 months of
his job, there is some problem in production department. You identify that his qualification is marketing,
but he is in charge of production department. Internal control should have detected his qualification at the
time of recruitment.
This is called internal control deficiency, because you didn’t identify the problem on time.

7) Describe the auditor's responsibilities related to required communications between the auditor and
those charged with governance (remove auditor committee) regarding internal control.
If auditor finds any deficiency or weakness in internal control, he should quickly report to the
management. The auditor should also ask the management for corrective action. If corrective action is
taken by the company then the auditor can ignore this.

Cases:
Case 1:
The firm of Hayes & Hu, Ltd., personal financial advisors in the Notting Hill section of London has
asked Joseph Smallman, Chartered Accountant (CA), to recommend a computer information
system. Hayes & Hu advise individuals on equity investments, manage finances for individuals
whom are outside the country and develop family budgets.
Required:

a. What information subsystems are Hayes & Hu likely to need?

AIS, computer software, application software, subsystem of production, subsystem of customers

b. What sort of outputs in the form of reports and documents will Hayes & Hu require?
Financial statements, budget reports, customer reports, production reports.

Case 2:
Aurello Pellegrini, Dottore Commercialista (CONSOB), is approached by his client who has just
reorganised his medium-sized manufacturing company to make it more structured by giving
responsibilities in related areas to one employee. The ‘supervisor for customers’ is responsible
for both collection of accounts receivable and maintenance of accounts receivable records. The
‘inventory coordinator’ is responsible for purchasing, receiving and storing inventory. The ‘payroll
agent’ handles
all payroll matters including personnel records, keeping time cards, preparation of payrolls and
distribution of payroll checks.
Required:
A. Consider each of these new positions and discuss the implications of their duties on
the internal control system. Discuss what sorts of problems could arise if these
positions are created.

Easily receive the Acc. Receivables and pocket it and write them as bad debts

Separation of authorization of transaction from the custody of related assets, easily pretend that he
purchased something and record it but in reality, he put the money in his pocket
If an employee quits his job, he can easily keep himself in the job in the records by changing his account
number to his account number and receive the employee salary