Chapter 24
Chapter 24
1) Auditors often integrate procedures for presentation and disclosure objectives with
A)
Tests for transaction-related
objectives Tests for balance-related objectives
Yes Yes
B)
Tests for transaction-related
objectives Tests for balance-related objectives
No No
C)
Tests for transaction-related
objectives Tests for balance-related objectives
Yes No
D)
Tests for transaction-related
objectives Tests for balance-related objectives
No Yes
Answer: A
Terms: Procedures for presentation and disclosure objectives
Diff: Easy
Objective: LO 24-1
AACSB: Reflective thinking
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3) An auditor is reconciling the amounts included in the long-term debt footnotes to the
information examined and supported in the audit files for long-term debt. Which audit objective
is being satisfied?
A) accuracy and valuation
B) occurrence and rights and obligations
C) completeness
D) classification and understandability
Answer: A
Terms: Presentation and disclosure-related objectives
Diff: Moderate
Objective: LO 24-1
AACSB: Reflective thinking
5) When an auditor reviews the financial statements to determine if assets are properly classified
between current and noncurrent, he is satisfying the audit objective of occurrence and rights and
obligations.
Answer: FALSE
Terms: Presentation and disclosure-related objectives
Diff: Moderate
Objective: LO 24-1
AACSB: Reflective thinking
2
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24.2 Learning Objective 24-2
3) Which of the following groups has the responsibility for identifying and deciding the
appropriate accounting treatment for recording or disclosing contingent liabilities?
A) auditors
B) legal counsel
C) management
D) management and the auditors
Answer: C
Terms: Recording or disclosing contingent liabilities
Diff: Easy
Objective: LO 24-2
AACSB: Reflective thinking
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4) You are auditing Rodgers and Company. You are aware of a potential loss due to
noncompliance with environmental regulations. Management has assessed that there is a 40%
chance that a $10M payment could result from the non-compliance. The appropriate financial
statement treatment is to
A) accrue a $4 million liability.
B) disclose a liability and provide a range of outcomes.
C) since there is less than a 50% chance of occurrence, ignore.
D) since there is greater that a remote chance of occurrence, accrue the $10 million.
Answer: B
Terms: Potential loss for noncompliance
Diff: Moderate
Objective: LO 24-2
AACSB: Analytic thinking
B)
Notes receivable discounted Product warranties
No No
C)
Notes receivable discounted Product warranties
Yes No
D)
Notes receivable discounted Product warranties
No Yes
Answer: A
Terms: Contingent liability; auditor particularly concerned
Diff: Easy
Objective: LO 24-2
AACSB: Reflective thinking
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6) Audit procedures related to contingent liabilities are initially focused on
A) accuracy.
B) completeness.
C) existence.
D) occurrence.
Answer: D
Terms: Audit procedures related to contingent liabilities
Diff: Easy
Objective: LO 24-2
AACSB: Reflective thinking
7) With which of the following client personnel would it generally not be appropriate to inquire
about commitments or contingent liabilities?
A) controller
B) president
C) accounts receivable clerk
D) vice president of sales
Answer: C
Terms: Inquire for commitments or contingent liabilities
Diff: Easy
Objective: LO 24-2
AACSB: Reflective thinking
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8) Inquiries of management regarding the possibility of unrecorded contingencies will be useful
in uncovering
A)
When management does not
Management's intentional failure to comprehend accounting disclosure
disclose existing contingencies. requirements.
Yes Yes
B)
When management does not
Management's intentional failure to comprehend accounting disclosure
disclose existing contingencies. requirements.
No No
C)
When management does not
Management's intentional failure to comprehend accounting disclosure
disclose existing contingencies. requirements.
Yes No
D)
When management does not
Management's intentional failure to comprehend accounting disclosure
disclose existing contingencies. requirements.
No Yes
Answer: D
Terms: Inquiries of management; Unrecorded contingencies
Diff: Easy
Objective: LO 24-2
AACSB: Reflective thinking
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10) If an auditor concludes there are contingent liabilities, then he or she must evaluate the
A)
Nature of the disclosure to be included in
Materiality of the potential liability. the financial statements.
Yes Yes
B)
Nature of the disclosure to be included in
Materiality of the potential liability. the financial statements.
No No
C)
Nature of the disclosure to be included in
Materiality of the potential liability. the financial statements.
Yes No
D)
Nature of the disclosure to be included in
Materiality of the potential liability. the financial statements.
No Yes
Answer: A
Terms: Contingent liabilities
Diff: Moderate
Objective: LO 24-2
AACSB: Reflective thinking
11) One of the primary approaches in dealing with uncertainties in loss contingencies uses a(n)
________ threshold.
A) monetary
B) materiality
C) probability
D) analytical
Answer: C
Terms: Contingent liabilities
Diff: Moderate
Objective: LO 24-2
AACSB: Reflective thinking
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12) If the auditor concludes that there are contingent liabilities, he or she must evaluate the
significance of the potential liability and the nature of the disclosure needed in the financial
statements. Which of the following statements is not true?
A) The potential liability is sufficiently well known in some instances to be included in the
financial statements as an actual liability.
B) Disclosure may be unnecessary if the contingency is highly remote or immaterial.
C) A CPA firm often obtains a separate evaluation of the potential liability from its own legal
counsel rather than relying on management or management's attorneys.
D) The client's attorneys must remain independent when evaluating the likelihood of losing the
lawsuit.
Answer: D
Terms: Contingent liabilities; significance of potential liability; nature of disclosure
Diff: Challenging
Objective: LO 24-2
AACSB: Reflective thinking
13) When using the probability threshold for contingencies, the likelihood of the occurrence of
the event is classified as
A) not likely, likely, or highly likely.
B) remote, reasonably possible, or probable.
C) slight, moderate, great.
D) remote, likely, possible.
Answer: B
Terms: Contingent liabilities
Diff: Easy
Objective: LO 24-2
AACSB: Reflective thinking
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15) Which of the following is not a common audit procedure used to search for contingent
liabilities?
A) examine letters of credit
B) examine payroll reports
C) review internal revenue agent reports
D) analyze legal expense
Answer: B
Terms: Contingent liabilities
Diff: Moderate
Objective: LO 24-2
AACSB: Reflective thinking
16) Contingent liability disclosure in the footnotes of the financial statements would normally be
made when
A) the outcome of the accounting event is deemed probable, but a reasonable estimation as to the
amount cannot be made by the client or auditor.
B) a reasonable estimation of the loss can be made, but the outcome is not probable.
C) the outcome of the accounting event is deemed probable, and a reasonable estimation as to the
amount can be made.
D) the outcome of the accounting event as well as a reasonable estimation of the loss cannot be
made.
Answer: A
Terms: Contingent liability disclosure
Diff: Challenging
Objective: LO 24-2
AACSB: Reflective thinking
17) Three conditions are required for a contingent liability to exist. Which of the following is not
one of those conditions?
A) There is a potential future payment to an outside party or the impairment of an asset that
resulted from an existing condition.
B) The outcome must be resolved by a third-party.
C) There is uncertainty about the amount of the future payment or impairment.
D) The outcome will be resolved by some future event or events.
Answer: B
Terms: Contingent liabilities
Diff: Moderate
Objective: LO 24-2
AACSB: Reflective thinking
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18) Distinguish between contingent liabilities and commitments.
Answer: Contingent liabilities are potential future obligations to an outside party for an
unknown amount resulting from activities that have already taken place. Commitments are
agreements that an entity will hold to a fixed set of conditions in the future regardless of what
happens to profits or the economy as a whole.
Terms: Contingent liabilities; commitments
Diff: Easy
Objective: LO 24-2
AACSB: Reflective thinking
19) Define the term contingent liability and discuss the criteria accountants and auditors use to
classify these accounting events.
Answer: A contingent liability is a potential future obligation to an outside party for an unknown
amount resulting from activities that have already taken place. Three conditions are required for
a contingent liability to exist: (1) there is a potential future payment to an outside party or the
impairment of an asset that resulted from an existing condition; (2) there is uncertainty about the
amount for the future payment or impairment; and (3) the outcome will be resolved by some
future event or events. Accounting standards describe three levels of likelihood of occurrence
and the appropriate financial statement treatment for each likelihood as follows:
a. Probable—future event likely to occur and amount can be reasonably estimated then the
financial statement accounts are adjusted. If amount cannot be reasonably estimated, then a
footnote disclosure is necessary.
b. Reasonably possible—chance of occurring is more than remote, but less than probable.
Footnote disclosure is necessary.
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21) What are the three required conditions for a contingent liability to exist?
Answer:
1. There is potential for future payment to an outside party or the impairment of an asset that
resulted from an existing condition.
2. There is uncertainty about the amount of the future payment or impairment.
3. The outcome will be resolved by some future event or events.
Terms: Conditions for contingent liability to exist
Diff: Moderate
Objective: LO 24-2
AACSB: Reflective thinking
22) An environmental clean-up lawsuit is pending against your client. What information about
the lawsuit would you as the auditor need in order to determine the proper accounting treatment?
Answer: The first step is to determine if a contingency exists. Three conditions are required for a
contingent liability to exist: (1) there is a potential future payment to an outside party or the
impairment of an asset that resulted from an existing condition; (2) there is uncertainty about the
amount for the future payment or impairment; and (3) the outcome will be resolved by some
future event or events.
Since the lawsuit meets the criteria for a contingent liability, the next step is to evaluate the
significance of the potential liability and the nature of the disclosure needed in the financial
statements to obtain evidence about the occurrence and right and obligations presentation and
disclosure objective. Accounting standards describe three levels of likelihood of occurrence and
the appropriate financial statement treatment for each likelihood as follows:
a. Probable—future event likely to occur and amount can be reasonably estimated then the
financial statement accounts are adjusted. If amount cannot be reasonably estimated, then a
footnote disclosure is necessary.
b. Reasonably possible—chance of occurring is more than remote, but less than probable.
Footnote disclosure is necessary.
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23) Discuss three audit procedures commonly used to search for contingent liabilities.
Answer:
• Inquire of management (orally and in writing) about the possibility of unrecorded
contingencies.
• Review current and previous years' internal revenue agent reports for income tax settlements.
• Review the minutes of directors' and stockholders' meetings for indications of lawsuits or
other contingencies.
• Analyze legal expense for the period under audit, and review invoices and statements from
legal counsel for indications of contingent liabilities.
• Obtain a letter from each major attorney performing legal services for the client as to the
status of pending litigation or other contingent liabilities.
• Review audit documentation for any information that may indicate a potential contingency.
• Examine letters of credit in force as of the balance sheet date and obtain a confirmation of the
used and unused balances.
Terms: Audit procedures for search of contingent liabilities
Diff: Moderate
Objective: LO 24-2
AACSB: Reflective thinking
24) A lawsuit has been filed against your client. If, in the opinion of legal counsel, the likelihood
your client will lose the lawsuit is remote, no financial statement accrual or disclosure of the
potential loss would generally be required.
Answer: TRUE
Terms: Lawsuit is remote; financial statement accrual or disclosure
Diff: Easy
Objective: LO 24-2
AACSB: Reflective thinking
25) Current professional auditing standards make it clear that management, not the auditor, is
responsible for identifying and deciding the appropriate accounting treatment for contingent
liabilities.
Answer: TRUE
Terms: Auditing standards; Contingent liabilities
Diff: Moderate
Objective: LO 24-2
AACSB: Reflective thinking
26) Many of the audit procedures for finding contingencies are usually performed as an integral
part of various segments of the audit rather than as a separate activity near the end of the audit.
Answer: TRUE
Terms: Existence of contingent liabilities
Diff: Moderate
Objective: LO 24-2
AACSB: Reflective thinking
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27) The probability threshold for dealing with uncertainty in loss contingencies uses the terms
likely and unlikely.
Answer: FALSE
Terms: Contingent liabilities
Diff: Moderate
Objective: LO 24-2
AACSB: Reflective thinking
28) The first stop in the audit of contingencies is to determine the amount of the contingency.
Answer: FALSE
Terms: Contingent liabilities
Diff: Moderate
Objective: LO 24-2
AACSB: Reflective thinking
1) Auditors will generally send a standard inquiry to the client's attorney letter to
A) only those attorneys who have devoted substantial time to client matters during the year.
B) every attorney that the client has been involved with in the current or preceding year, plus any
attorney the client engages on occasion.
C) every attorney whose legal fees for the year exceed a materiality threshold.
D) only the attorney who represents the client in proceeding where the client is defendant.
Answer: B
Terms: Standard inquiry to the client's attorney letter
Diff: Easy
Objective: LO 24-3
AACSB: Reflective thinking
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2) What needs to be included in a standard inquiry to the client's attorney letter sent to a client's
legal counsel?
A)
Any pending threatened
litigation with which the
attorney has had significant The amount of legal fees paid
involvement by the client to the attorney
Yes Yes
B)
Any pending threatened
litigation with which the
attorney has had significant The amount of legal fees paid
involvement by the client to the attorney
No No
C)
Any pending threatened
litigation with which the
attorney has had significant The amount of legal fees paid
involvement by the client to the attorney
Yes No
D)
Any pending threatened
litigation with which the
attorney has had significant The amount of legal fees paid
involvement by the client to the attorney
No Yes
Answer: C
Terms: Standard inquiry to the client's attorney letter
Diff: Easy
Objective: LO 24-3
AACSB: Reflective thinking
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3) Auditors, as part of completing the audit, will request the client to send a standard inquiry to
the client's attorney letter to those attorneys the company has been consulting with during the
year under audit regarding legal matters of concern to the company. The primary reason the
auditor requests this information is to
A) determine the range of probable loss for asserted claims.
B) obtain a professional opinion about the expected outcome of existing lawsuits and the likely
amount of the liability, including court costs.
C) obtain an outside opinion of the probability of losses in determining accruals for
contingencies.
D) obtain an outside opinion of the probability of losses in determining the proper footnote
disclosure.
Answer: B
Terms: Completing the audit; Letter of inquiry
Diff: Moderate
Objective: LO 24-3
AACSB: Reflective thinking
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5) What is one of the main reasons an attorney may refuse to provide auditors with complete
information about contingent liabilities?
A)
The attorneys refuse to
respond due to a lack of
The attorneys refuse to knowledge about matters
disclose information they involving contingent
consider confidential. liabilities.
Yes Yes
B)
The attorneys refuse to
respond due to a lack of
The attorneys refuse to knowledge about matters
disclose information they involving contingent
consider confidential. liabilities.
No No
C)
The attorneys refuse to
respond due to a lack of
The attorneys refuse to knowledge about matters
disclose information they involving contingent
consider confidential. liabilities.
Yes No
D)
The attorneys refuse to
respond due to a lack of
The attorneys refuse to knowledge about matters
disclose information they involving contingent
consider confidential. liabilities.
No Yes
Answer: A
Terms: Standard inquiry to the client's attorney letter
Diff: Easy
Objective: LO 24-3
AACSB: Reflective thinking
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6) An attorney is aware of a violation of a patent agreement that could result in a significant loss
to the client if it were known. This is an example of a(n)
A) commitment.
B) unasserted claim.
C) pending litigation.
D) subsequent event.
Answer: B
Terms: Standard inquiry to the client's attorney letter
Diff: Moderate
Objective: LO 24-3
AACSB: Analytic thinking
7) Management furnishes the independent auditor with information concerning litigation, claims,
and assessments. Which of the following is the auditor's primary means of initiating action to
corroborate such information?
A) Request that client lawyers undertake a reconsideration of matters of litigation, claims, and
assessments with which they were consulted during the period under examination.
B) Request that client management send a standard inquiry to the client's attorney letter to those
lawyers with whom management consulted concerning litigation, claims, and assessments.
C) Request that client lawyers provide a legal opinion concerning the policies and procedures
adopted by management to identify, evaluate, and account for litigation, claims, and assessments.
D) Request that client management engage outside attorneys to suggest wording for the text of a
footnote explaining the nature and probable outcome of existing litigation, claims, and
assessments.
Answer: B
Terms: Corroborate information concerning litigation, claims, and assessments
Diff: Challenging
Objective: LO 24-3
AACSB: Reflective thinking
8) If an attorney refuses to provide the auditor with information about material existing lawsuits
or unasserted claims,
A) the attorney may face sanctions from the American Bar Association.
B) the auditors must modify their audit report to reflect the lack of available evidence.
C) the attorney can no longer represent the client.
D) the auditor must withdraw from the engagement.
Answer: B
Terms: Response to client's letter of inquiry
Diff: Moderate
Objective: LO 24-3
AACSB: Reflective thinking
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9) As directed by the Sarbanes-Oxley Act,
A) an attorney must report material violations of federal securities law to the public company's
chief legal counsel or chief executive officer.
B) attorneys cannot breach confidentiality rules even if a client is committing a crime or a fraud.
C) if the audit committee fails to remedy any material violations of the federal securities law, the
attorney must report the violation to the SEC.
D) All of the above are required by Sarbanes-Oxley.
Answer: A
Terms: Legal letter to client's attorneys
Diff: Moderate
Objective: LO 24-3
AACSB: Reflective thinking
Topic: SOX
10) Attorneys in recent years have become reluctant to provide certain information to auditors
because of their own exposure to legal liability for providing incorrect or confidential
information. State the two main reasons that attorneys refuse to provide the auditors with
complete information.
Answer:
• The attorneys refuse to respond due to a lack of knowledge about matters involving
contingent liabilities.
• The attorneys refuse to disclose information that they consider confidential.
Terms: Legal letter to client's attorneys
Diff: Easy
Objective: LO 24-3
AACSB: Reflective thinking
Topic: Public
11) State three items that should be included in a standard inquiry to the client's attorney letter.
Answer:
• A list including (1) pending threatened litigation and (2) asserted or unasserted claims or
assessments with which the attorney has had significant involvement. This list is typically
prepared by management, but management may request that the attorney prepare the list.
• A request that the attorney furnish information or comment about the progress of each item
listed, the legal action the client intends to take, the likelihood of an unfavorable outcome, and an
estimate of the amount or range of the potential loss.
• A request for the identification of any unlisted pending or threatened legal actions or a
statement that the client's list is complete.
• A statement informing the attorney of his or her responsibility to inform management of legal
matters requiring disclosure in the financial statements and to respond directly to the auditor.
Terms: Inquiry of attorney letter
Diff: Challenging
Objective: LO 24-3
AACSB: Reflective thinking
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12) When preparing a standard inquiry to the client's attorney letter, the client's letterhead should
be used, and the letter should be signed by the client company's officials.
Answer: TRUE
Terms: Standard inquiry to the client's attorney letter
Diff: Moderate
Objective: LO 24-3
AACSB: Reflective thinking
13) In a standard inquiry to the client's attorney letter, the attorney is requested to communicate
about contingencies up to the balance sheet date.
Answer: FALSE
Terms: Standard inquiry to the client's attorney letter
Diff: Moderate
Objective: LO 24-3
AACSB: Reflective thinking
14) If an attorney refuses to provide the auditor with information about material existing lawsuits
or unasserted claims, current professional standards require that the auditor consider the refusal
as a scope limitation.
Answer: TRUE
Terms: Attorney refuses to provide auditor with information about material existing lawsuits
Diff: Easy
Objective: LO 24-3
AACSB: Reflective thinking
1) The auditor has a responsibility to review transactions and activities occurring after the
balance sheet date to determine whether anything occurred that might affect the statements being
audited. The procedures required to verify these transactions are commonly referred to as the
review for
A) contingent liabilities.
B) subsequent year's transactions.
C) late unusual occurrences.
D) subsequent events.
Answer: D
Terms: Review transactions and activities occurring after balance sheet date
Diff: Easy
Objective: LO 24-4
AACSB: Reflective thinking
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2) Which type of subsequent event requires consideration by management and evaluation by the
auditor?
A)
Subsequent events that do not have a
Subsequent events that have a direct direct effect on the financial
effect on the financial statements and statements but for which disclosure
require adjustment may be required
Yes Yes
B)
Subsequent events that do not have a
Subsequent events that have a direct direct effect on the financial
effect on the financial statements and statements but for which disclosure
require adjustment may be required
No No
C)
Subsequent events that do not have a
Subsequent events that have a direct direct effect on the financial
effect on the financial statements and statements but for which disclosure
require adjustment may be required
Yes No
D)
Subsequent events that do not have a
Subsequent events that have a direct direct effect on the financial
effect on the financial statements and statements but for which disclosure
require adjustment may be required
No Yes
Answer: A
Terms: Subsequent events requiring consideration by management
Diff: Easy
Objective: LO 24-4
AACSB: Reflective thinking
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3) Whenever subsequent events are used to evaluate the amounts included in the statements, care
must be taken to distinguish between conditions that existed at the balance sheet date and those
that come into being after the balance sheet date. The subsequent information should not be
incorporated directly into the statements if the conditions causing the change in valuation
A) took place before the balance sheet date.
B) did not take place until after the balance sheet date.
C) occurred both before and after the balance sheet date.
D) are reimbursable through insurance policies.
Answer: B
Terms: Subsequent events; balance sheet date and after the end of the year
Diff: Easy
Objective: LO 24-4
AACSB: Reflective thinking
4) An auditor has the responsibility to actively search for subsequent events that occur
subsequent to the
A) balance sheet date.
B) date of the auditor's report.
C) balance sheet date, but prior to the audit report.
D) date of the management representation letter.
Answer: C
Terms: Subsequent events
Diff: Easy
Objective: LO 24-4
AACSB: Reflective thinking
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6) After the balance sheet date, but prior to the issuance of the audit report, the client suffers an
uninsured loss of their inventory as a result of a fire. The amount of the loss is material. The
auditor should
A) adjust the financial statements for the year under audit.
B) add a paragraph to the audit report.
C) advise the client to disclose the event in the notes to the financial statements.
D) advise the client to delay issuing the financial statements until the economic loss can be
determined.
Answer: C
Terms: Event will have a material effect on the financial statements
Diff: Easy
Objective: LO 24-4
AACSB: Analytic thinking
7) The auditor has completed her assessment of subsequent events. The proper accounting for
subsequent events that have a direct effect on the financial statements is to
A) adjust the financial statements for the year under audit.
B) disclose in the notes to financial statement the amount of the adjustment.
C) duly note in the audit workpapers that next year's financial statements need to be adjusted.
D) make no adjustment of the financial statements for the year under audit.
Answer: A
Terms: Subsequent events; direct effect on the financial statements
Diff: Moderate
Objective: LO 24-4
AACSB: Reflective thinking
8) The audit procedures for the subsequent events review can be divided into two categories: (1)
procedures integrated as a part of the verification of year-end account balances, and (2) those
performed specifically for the purpose of discovering subsequent events. Which of the following
procedures is in the first category?
A) Inquire of client regarding contingent liabilities.
B) Obtain a letter of representation written by client.
C) Subsequent period sales and purchases transactions are examined to determine whether the
cutoff is accurate.
D) Review journals and ledgers of year 2 to determine the existence of any transactions related to
year 1.
Answer: C
Terms: Audit procedures for subsequent events review
Diff: Moderate
Objective: LO 24-4
AACSB: Reflective thinking
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9) The audit procedures for the subsequent events review can be divided into two categories:
(1) procedures normally integrated as a part of the verification of year-end account balances, and
(2) those performed specifically for the purpose of discovering subsequent events. Which of the
following procedures is in the second category?
A) Correspond with attorneys.
B) Test the collectability of accounts receivable by reviewing subsequent period cash receipts.
C) Subsequent period sales and purchases transactions are examined to determine whether the
cutoff is accurate.
D) Compare the subsequent-period purchase price of inventory with the recorded cost as a test of
lower of cost or market valuation.
Answer: A
Terms: Audit procedures for subsequent events review
Diff: Moderate
Objective: LO 24-4
AACSB: Reflective thinking
10) Which of the following would be a subsequent discovery of facts which would not require a
response by the auditor?
A) discovery of the inclusion of material nonexistent sales
B) discovery of the failure to write off material obsolete inventory
C) discovery of the omission of a material footnote
D) discovery of management's intent to increase selling prices in the future
Answer: D
Terms: Subsequent discovery of facts
Diff: Moderate
Objective: LO 24-4
AACSB: Reflective thinking
11) In connection with the annual audit, which of the following is not a "subsequent events"
procedure?
A) Prepare any necessary closing journal entries.
B) Examine the minutes of stockholders and directors meetings subsequent to the balance sheet
date.
C) Review journals and ledgers.
D) Obtain a letter of representation.
Answer: A
Terms: Subsequent events procedure
Diff: Moderate
Objective: LO 24-4
AACSB: Reflective thinking
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12) An auditor performs interim work at various times throughout the year. The auditor's
subsequent events work should be extended to the date of
A) the auditor's report.
B) a post-dated footnote.
C) the next scheduled interim visit.
D) the final billing for audit services rendered.
Answer: A
Terms: Interim work; Subsequent events
Diff: Moderate
Objective: LO 24-4
AACSB: Reflective thinking
13) Which event that occurred after the end of the fiscal year under audit but prior to issuance of
the auditor's report would not require disclosure in the financial statements?
A) sale of a bond or capital stock issue
B) loss of plant or inventories as a result of fire or flood
C) a significant decline in the market price of the corporation's stock
D) a merger or acquisition
Answer: C
Terms: Event that occurred after the end of the fiscal year
Diff: Moderate
Objective: LO 24-4
AACSB: Analytic thinking
14) Which of the following material events occurring subsequent to the balance sheet date would
require an adjustment to the financial statements before they could be issued?
A) loss of a plant as a result of a flood
B) sale of long-term debt or capital stock
C) settlement of litigation in excess of the recorded liability
D) major purchase of a business that is expected to double the sales volume
Answer: C
Terms: Events occurring subsequent to the balance sheet date; Adjustment
Diff: Moderate
Objective: LO 24-4
AACSB: Analytic thinking
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15) If the auditor determines that a subsequent event that affects the current period financial
statements occurred after fieldwork was completed but before the audit report was issued, what
date(s) may the auditor use on the report?
A)
The date of the The date of the The date on which the last day of
original last day of subsequent fieldwork occurred along with the
fieldwork only. event only. date of the subsequent event.
Yes Yes No
B)
The date of the The date of the The date on which the last day of
original last day of subsequent fieldwork occurred along with the
fieldwork only. event only. date of the subsequent event.
No Yes Yes
C)
The date of the The date of the The date on which the last day of
original last day of subsequent fieldwork occurred along with the
fieldwork only. event only. date of the subsequent event.
No Yes No
D)
The date of the The date of the The date on which the last day of
original last day of subsequent fieldwork occurred along with the
fieldwork only. event only. date of the subsequent event.
No No Yes
Answer: B
Terms: Subsequent event; report date
Diff: Challenging
Objective: LO 24-4
AACSB: Analytic thinking
16) An auditor's decision concerning whether or not to dual date an audit report is primarily
based on the auditor's decision to
A) extend appropriate audit procedures.
B) assume responsibility for events after the date of the auditor's report.
C) assume responsibility for event from fiscal year-end to the date of the audit report.
D) roll the dice and hope for a successful outcome.
Answer: A
Terms: Dual date audit report
Diff: Challenging
Objective: LO 24-4
AACSB: Reflective thinking
25
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17) The auditor's responsibility for "reviewing the subsequent events" of a public company that
is about to issue new securities is normally limited to the period of time
A) beginning with the balance sheet date and ending with the date of the auditor's report.
B) beginning with the start of the fiscal year under audit and ending with the balance sheet date.
C) beginning with the start of the fiscal year under audit and ending with the date of the auditor's
report.
D) beginning with the balance sheet date and ending with the date the registration statement
becomes effective.
Answer: D
Terms: Reviewing subsequent events; public company; issue new securities
Diff: Challenging
Objective: LO 24-4
AACSB: Reflective thinking
18) Subsequent events affecting the realization of assets ordinarily will require an adjustment of
the financial statements under examination because such events typically represent
A) the culmination of conditions that existed at the balance sheet date.
B) additional new information related to events that were in existence on the balance sheet date.
C) final estimates of losses relating to casualties occurring in the subsequent events period.
D) preliminary estimate of losses relating to new events that occurred subsequent to the balance
sheet date.
Answer: B
Terms: Subsequent events; realization of assets
Diff: Challenging
Objective: LO 24-4
AACSB: Reflective thinking
19) An auditor's decision concerning whether or not to "dual date" the audit report is based upon
the auditor's willingness to
A) extend auditing procedures and assume responsibility for a greater period of time.
B) accept responsibility for subsequent events.
C) permit inclusion of a footnote captioned: event (unaudited) subsequent to the date of the
auditor's report.
D) assume responsibility for events subsequent to the issuance of the auditor's report.
Answer: A
Terms: Dual date audit report
Diff: Challenging
Objective: LO 24-4
AACSB: Reflective thinking
26
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20) Auditors of accelerated filer public companies
A) are responsible for reviewing subsequent events for a period of up to six months after the
balance sheet date.
B) must always dual-date their audit reports.
C) must inquire about and consider any information about subsequent events that materially
affects the effectiveness of internal control over financial reporting.
D) must perform all of the above procedures.
Answer: C
Terms: Accelerated filers and subsequent events
Diff: Moderate
Objective: LO 24-4
AACSB: Reflective thinking
Topic: Public
21) A client has a calendar year-end. Listed below are four events that occurred after
December 31. Which one of these subsequent events might result in adjustment of the
December 31 financial statements?
A) sale of a major subsidiary
B) adoption of accelerated depreciation methods
C) write-off of a substantial portion of inventory as obsolete
D) collection of 90% of the accounts receivable existing at December 31
Answer: C
Terms: Subsequent events
Diff: Challenging
Objective: LO 24-4
AACSB: Analytic thinking
22) The auditor's responsibility with respect to events occurring between the balance sheet date
and the end of the audit examination is best expressed by which of the following statements?
A) The auditor is fully responsible for events occurring in the subsequent period and should
extend all detailed procedures through the last day of fieldwork.
B) The auditor is responsible for determining that a proper cutoff has been made and performing
a general review of events occurring in the subsequent period.
C) The auditor's responsibility is to determine that a proper cutoff has been made and that
transactions recorded on or before the balance sheet date actually occurred.
D) The auditor has no responsibility for events occurring in the subsequent period unless these
events affect transactions recorded on or before the balance sheet date.
Answer: B
Terms: Events occurring between balance sheet date and end of audit examination
Diff: Challenging
Objective: LO 24-4
AACSB: Reflective thinking
27
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23) The fieldwork for the December 31, 2016 audit of Schmidt Corporation ended on March 17,
2017. The financial statements and auditor's report were issued on March 29, 2017. In each of
the material situations (1 through 5) below, indicate the appropriate action (a, b, c). The possible
actions are as follows
________ 2. On February 17, 2017, Schmidt Corporation sold some machinery for its book
value.
________ 3. On February 20, 2017 a flood destroyed the entire uninsured inventory in one of
Schmidt's warehouses.
________ 4. On January 5, 2017, there was a significant decline in the market value of the
securities held for resale from their value as of the balance sheet date.
________ 5. On March 10, 2017, the company settled a lawsuit at an amount significantly higher
than the amount recorded as a liability on the books as of the balance sheet date.
Answer:
1. a
2. c
3. b
4. b
5. a
Terms: Actions for subsequent events
Diff: Challenging
Objective: LO 24-4
AACSB: Analytic thinking
28
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24) State the two primary types of subsequent events that require consideration by management
and evaluation by the auditor, and give two examples of each type.
Answer:
1. Events that occur after the balance sheet date which provide additional information to
management that helps them determine the fair presentation of account balances as of the
balance sheet date. Information about these events helps auditors in verifying the balances. These
events have a direct effect on the financial statements and require adjustment. Examples include
declaration of bankruptcy by a customer with an outstanding accounts receivable balance due to
deteriorating financial condition; settlement of litigation at an amount different from the amount
recorded on the books; and the disposal of equipment not being used in operations at a price
below the current book value.
2. Events that have no direct effect on the financial statements but for which disclosure is
required. Subsequent events of this type are events that provide evidence about conditions which
did not exist at the date of the balance sheet being reported on but arose after the balance sheet
date and may be significant enough to require disclosure. Examples include a decline in the
market value of securities held for temporary investment or resale; issuance of bonds or equity
securities; a decline in the market value of inventory as a consequence of government action
barring further sale of a product; the uninsured loss of inventories as a result of fire; and a merger
or an acquisition.
Terms: Types of subsequent events
Diff: Moderate
Objective: LO 24-4
AACSB: Reflective thinking
25) The issuance of bonds by the client subsequent to the balance sheet date would require a
footnote disclosure in, but no adjustment to, the financial statements under audit.
Answer: TRUE
Terms: Issuance of bonds by client subsequent to year-end
Diff: Easy
Objective: LO 24-4
AACSB: Reflective thinking
26) Subsequent events which require adjustment to the financial statements provide additional
information about significant conditions/events which did not exist at the balance sheet date.
Answer: FALSE
Terms: Subsequent events
Diff: Moderate
Objective: LO 24-4
AACSB: Reflective thinking
29
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27) When subsequent events are used to evaluate the amounts included in the year-end financial
statements, auditors must distinguish between conditions that existed at the balance sheet date
and those that came into being after the balance sheet date.
Answer: TRUE
Terms: Subsequent events
Diff: Moderate
Objective: LO 24-4
AACSB: Reflective thinking
28) The auditor's responsibility for reviewing subsequent events is normally limited to thirty
days after the balance sheet date.
Answer: FALSE
Terms: Subsequent events; balance sheet date and after the end of the year
Diff: Easy
Objective: LO 24-4
AACSB: Reflective thinking
1) The date of the management representation letter received from the client should
A) be the date of latest subsequent event disclosed in the notes to the financial statements.
B) be dated no earlier than the date of the audit report.
C) have the same date as the date of the balance sheet.
D) have the same date as the date of the engagement letter.
Answer: B
Terms: Management representation letter
Diff: Easy
Objective: LO 24-5
AACSB: Reflective thinking
30
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2) Which of the following procedures and methods are important in assessing a company's
ability to continue as a going concern?
A)
Discussions with management regarding Evaluation of management's plans to
potential financial difficulties avoid bankruptcy
Yes Yes
B)
Discussions with management regarding Evaluation of management's plans to
potential financial difficulties avoid bankruptcy
No No
C)
Discussions with management regarding Evaluation of management's plans to
potential financial difficulties avoid bankruptcy
Yes No
D)
Discussions with management regarding Evaluation of management's plans to
potential financial difficulties avoid bankruptcy
No Yes
Answer: A
Terms: Going concern
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
31
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4) When should auditors generally assess a client's ability to continue as a going concern?
A) upon completion of the audit
B) during the planning stages of the audit
C) throughout the entire audit process
D) during testing and completion phases of the audit
Answer: C
Terms: Going concern
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
5) Which of the following would the auditor expect to find in the client's management
representation letter?
A) management's recommendations for internal control effectiveness improvements
B) management's plans for improving product quality
C) management's compliance with contractual arrangements that impact the financial statements
D) management's goals for improving earnings per share
Answer: C
Terms: Management representation letter
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
6) Auditing standards require that the auditor evaluate whether there is a substantial doubt about
a client's ability to continue as a going concern for at least
A) one quarter beyond the balance sheet date.
B) one quarter beyond the date of the auditor's report.
C) one year beyond the balance sheet date.
D) one year beyond the date of the auditor's report.
Answer: C
Terms: Auditing standards; Going concern issues
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
7) Auditing standards require auditors to evaluate whether there is substantial doubt about a
client's ability to continue as a going concern. One of the most important audit procedures to
perform to assess the going concern question is
A) analytical procedures.
B) confirmations from creditors.
C) statistical sampling procedures.
D) tests of internal controls.
Answer: A
Terms: Audit procedures to assess going concern
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
32
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8) Which of the following statements regarding the letter of representation is not correct?
A) It is prepared on the client's letterhead.
B) It is addressed to the CPA firm.
C) It is signed by high-level corporate officials, usually the president and chief financial officer.
D) It is optional, not required, that the auditor obtain such a letter from management.
Answer: D
Terms: Letter of representation
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
9) Refusal by a client to prepare and sign the representation letter would require the auditor to
issue a(n)
A) qualified opinion or a disclaimer of opinion.
B) adverse opinion or a disclaimer of opinion.
C) qualified or an adverse opinion.
D) unqualified opinion with an explanatory paragraph.
Answer: A
Terms: Refusal to prepare and sign the letter of representation
Diff: Easy
Objective: LO 24-5
AACSB: Reflective thinking
33
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11) Which of the following is correct regarding supplementary information?
A) The auditor must express an opinion on the supplementary information.
B) When reporting on supplementary information, the auditor uses a different materiality
threshold from that used in forming an opinion on the basic financial statements.
C) If the auditor's report on the audited financial statements contains an adverse opinion, the
auditor can still issue an unqualified opinion on the supplementary information.
D) The auditor can issue a separate report on the supplementary information; it does not need to
be part of the report on the financial statements.
Answer: D
Terms: Supplementary information accompanying basic financial statements
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
12) Which of the following is not one of the categories of items included in the letter of
representation?
A) subsequent events
B) completeness of information
C) recognition, measurement, and disclosure
D) materiality
Answer: D
Terms: Client letter of representation
Diff: Easy
Objective: LO 24-5
AACSB: Reflective thinking
13) Which of the following audit procedures would most likely assist an auditor in identifying
conditions and events that may indicate there could be substantial doubt about an entity's ability
to continue as a going concern?
A) review compliance with the terms of debt agreements
B) confirmation of accounts receivable from principal customers
C) reconciliation of interest expense with debt outstanding
D) confirmation of bank balances
Answer: A
Terms: Audit procedures; Entity's ability to continue as a going concern
Diff: Challenging
Objective: LO 24-5
AACSB: Reflective thinking
34
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14) Which of the following statements is correct?
A) A letter of representation is documentation of management's acceptance of responsibility for
the financial statements and is deemed to be reliable evidence.
B) A letter of representation is not deemed to be reliable evidence because of the potential
incompetence of management.
C) A letter of representation is not deemed to be reliable evidence because it is a written
statement from a nonindependent source.
D) A letter of representation is documentation of the CPA's acceptance of responsibility for the
audit of the financial statement and is deemed to be reliable.
Answer: C
Terms: Letter of representation
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
15) Auditing standards require the auditor to ________ other information included in annual
reports pertaining directly to the financial statements.
A) audit
B) express an opinion on
C) read
D) analyze
Answer: C
Terms: Other information included in annual reports
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
16) An auditor must obtain written client representations that might be signed by all but which of
the following?
A) treasurer
B) chief financial officer
C) vice president of operations
D) chief executive officer
Answer: C
Terms: Client representations signed by
Diff: Easy
Objective: LO 24-5
AACSB: Reflective thinking
35
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17) Which of the following is not a reason why the auditor requests that the client provide a
letter of representation?
A) Professional auditing standards require the auditor to obtain a letter of representation.
B) It impresses upon management its responsibility for the accuracy of the information in the
financial statements.
C) It provides written documentation of the oral responses already received to inquiries of
management.
D) It determines the type of opinion the auditor will issue on the financial statements.
Answer: D
Terms: Letter of representation
Diff: Challenging
Objective: LO 24-5
AACSB: Reflective thinking
18) At the completion of the audit, management is asked to make a written statement that it is not
aware of any undisclosed contingent liabilities. This statement would appear in the
A) management letter.
B) letter of inquiry.
C) letters testamentary.
D) management letter of representation.
Answer: D
Terms: Completion of audit; written statement by management
Diff: Easy
Objective: LO 24-5
AACSB: Reflective thinking
19) What two steps must an auditor take if they have reservations about the audit client
continuing as a going concern?
Answer: 1. Evaluate management's plan to avoid bankruptcy.
2. Determine the feasibility of management achieving those plans.
Terms: Going concern
Diff: Easy
Objective: LO 24-5
AACSB: Reflective thinking
36
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21) List four specific matters that should be included in a client representation letter.
Answer:
• Management's acknowledgment of its responsibility for the fair presentation of the financial
statements
• Management's belief that the financial statements are fairly presented in conformity with
applicable accounting standards
• Availability of all financial records and related data
• Completeness and availability of all minutes of meetings of stockholders, directors, and
committees of directors
• Absence of unrecorded transactions
• Management's belief that the effects of any uncorrected financial statement misstatements are
immaterial to the financial statements
• Information concerning fraud involving (a) management, (b) employees who have significant
roles in internal control, or (c) others where fraud could have a material effect on the financial
statements
• Information concerning related-party transactions and amounts receivable or payable to
related parties
• Unasserted claims or assessments that the entity's lawyer has advised are probable of
assertion and must be disclosed in accordance with accounting standards
• Bankruptcy of a major customer with an outstanding account receivable at the balance sheet
date
• A merger or acquisition after the balance sheet date
Terms: Management representation letter
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
22) Besides the search for contingent liabilities and the review for subsequent events, the auditor
has four important final evidence accumulation responsibilities, all of which are required by
current professional auditing standards. Discuss each of these four responsibilities.
Answer:
• Final analytical procedures performed as a final review for material misstatements or
financial problems and to help the auditor take a final objective look at the financial statements.
• Evaluate the going concern assumption.
• Obtain a management representation letter documenting management's most important oral
representations during the audit.
• Consider supplementary information included in published annual reports pertaining directly
to the financial statements.
Terms: Final evidence accumulation responsibilities required by professional auditing standards
Diff: Challenging
Objective: LO 24-5
AACSB: Reflective thinking
37
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23) Current professional auditing standards require the performance of analytical procedures
during the planning and completion phases of the audit.
Answer: TRUE
Terms: Analytical procedures; Planning and completion phases of the audit
Diff: Easy
Objective: LO 24-5
AACSB: Reflective thinking
24) Current professional auditing standards mandate the use of analytical procedures during the
testing phase of the audit.
Answer: FALSE
Terms: Professional auditing standards; Analytical procedures; Testing phase of audit
Diff: Easy
Objective: LO 24-5
AACSB: Reflective thinking
25) Auditing standards require the auditor's assessment of going concern issues.
Answer: TRUE
Terms: Auditing standards; Going concern issues
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
26) Results from the final analytical procedures may indicate that additional audit evidence is
necessary.
Answer: TRUE
Terms: Analytical procedures in stages of audit
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
27) Although the letter of representation is typed on the client's letterhead and signed by the
client, it is common for the auditor to prepare the letter.
Answer: TRUE
Terms: Letter of representation
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
28) Auditors of public companies must obtain certain representations from management
regarding internal control over financial reporting.
Answer: TRUE
Terms: Representations from management regarding internal control
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
Topic: Public
38
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29) At the completion of the audit, management is typically asked to make a written statement as
a part of the engagement letter that it is aware of no undisclosed contingent liabilities.
Answer: FALSE
Terms: Completion of audit; written statement by management; undisclosed liabilities
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
30) Auditors are required to obtain a letter of representation that describes management's planned
solutions to all internal control weaknesses identified during an audit.
Answer: FALSE
Terms: Letter of representation
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
31) The letter of representation is prepared on the CPA firm's letterhead, addressed to the client's
chief executive officer, and signed by the audit engagement partner.
Answer: FALSE
Terms: Letter of representation
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
32) If the client refuses to prepare and sign a letter of representation, the auditor would be
required to issue either a qualified opinion or a disclaimer of opinion.
Answer: TRUE
Terms: Letter of representation; issue opinion
Diff: Moderate
Objective: LO 24-5
AACSB: Reflective thinking
39
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24.6 Learning Objective 24-6
40
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4) There are three reasons why an experienced member of the audit firm must thoroughly review
audit documentation of the completion of the audit, including
A) to evaluate the performance of inexperienced personnel.
B) to make sure that the audit meets the CPA firm's standard of performance.
C) to counteract the bias that often enters into the auditor's judgment.
D) all of the above.
Answer: D
Terms: Audit documentation
Diff: Moderate
Objective: LO 24-6
AACSB: Reflective thinking
41
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5) Match seven of the terms (a-p) with the description/definitions provided below (1-7):
a. commitments
b. completing the engagement checklist
c. contingent liability
d. dual-dated audit report
e. financial statement disclosure checklist
f. independent review
g. inquiry of client's attorneys
h. letter of representation
i. other information in annual reports
j. review for subsequent events
k. subsequent events
l. unadjusted misstatement worksheet
m. management letter
n. pending claim
o. unasserted claim
p. Audit documentation review
________ 1. a review of the financial statements and the entire set of audit files by an
independent reviewer to whom the audit team must justify the evidence accumulated and the
conclusions reached
________ 2. a potential future obligation to an outside party for an unknown amount resulting
from activities that have already taken place
________ 3. a written communication from the client to the auditor formalizing statements that
the client has made about matters pertinent to the audit
________ 4. a potential legal claim against a client where the condition for a claim exists but no
claim has been filed
________ 5. transactions that occurred after the balance sheet date, which affect the fair
presentation or disclosure of the statements being audited
________ 6. agreements that the entity will hold to a fixed set of conditions, such as the purchase
or sale of merchandise at a stated price
________ 7. the use of one audit report date for normal subsequent events and a later date for
one or more subsequent events
Answer: 1. f, 2. c, 3. h, 4. o, 5. k, 6. a, 7. d
Terms: Independent review; Contingent liability; Letter of representation; Unasserted claim;
Subsequent events; Commitments; Dual-dated audit report
Diff: Moderate
Objective: LO 24-6
AACSB: Reflective thinking
42
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6) List the three reasons why an experienced member of the audit firm must thoroughly review
audit documentation at the completion of the audit.
Answer:
1. To evaluate the performance of inexperienced personnel
2. To make sure that the audit meets the CPA firm's standard of performance
3. To counteract the bias that often enters into the auditor's judgment
Terms: Audit documentation
Diff: Moderate
Objective: LO 24-6
AACSB: Reflective thinking
8) If, during the completion phase of the audit, the auditor determines that he or she has not
obtained sufficient evidence to draw a conclusion about the fairness of the client's financial
statements, there are two choices: accumulate additional evidence or issue either a qualified or an
adverse opinion.
Answer: FALSE
Terms: Sufficient evidence to draw a conclusion
Diff: Moderate
Objective: LO 24-6
AACSB: Reflective thinking
9) After performing all audit procedures in each area, the auditor must integrate the results into
an overall conclusion about the financial statements.
Answer: TRUE
Terms: Sufficient evidence to draw a conclusion
Diff: Moderate
Objective: LO 24-6
AACSB: Reflective thinking
43
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24.7 Learning Objective 24-7
1) The auditor is responsible for communicating significant internal control deficiencies to the
audit committee, or those charged with governance. This communication
A) may be oral or written.
B) must be oral.
C) must be written.
D) must be oral via direct communication.
Answer: C
Terms: Communicate significant internal control deficiencies
Diff: Easy
Objective: LO 24-7
AACSB: Reflective thinking
2) Which of the following statements is most correct about an auditor's required communication
with management and those charged with corporate governance?
A) The auditor is required to inform those charged with governance about significant errors
discovered and subsequently corrected by management.
B) Any significant matter reported to those charged with governance must also be communicated
to management.
C) Communication is required before the audit report is issued.
D) The auditor does not have any requirement to communicate with anyone other than the
company's senior management.
Answer: A
Terms: Required communication with management; corporate governance
Diff: Moderate
Objective: LO 24-7
AACSB: Reflective thinking
44
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4) When communicating with the audit committee and management,
A) only material fraud and illegal acts are required by auditing standards to be communicated.
B) all internal control deficiencies are required by auditing standards to be communicated.
C) the communications should be made in a timely manner to allow those charged with
governance to take appropriate actions.
D) all communications with the audit committee and management must be in writing.
Answer: C
Terms: Communicated to the audit committee or designate body
Diff: Moderate
Objective: LO 24-7
AACSB: Reflective thinking
5) Auditing standards require the auditor to communicate all management frauds and illegal acts
to the audit committee
A) only if the act is immaterial.
B) only if the act is material.
C) only if the act is highly material.
D) regardless of materiality.
Answer: D
Terms: Auditing standards; Frauds and illegal acts; Audit committee
Diff: Easy
Objective: LO 24-7
AACSB: Reflective thinking
6) List the four principal purposes of the required communication with the audit committee
regarding certain additional information obtained during the audit.
Answer:
• To communicate auditor responsibilities in the audit of financial statements
• To provide an overview of the scope and timing of the audit
• To provide those charged with governance with significant findings arising during the audit
• To obtain from those charged with governance information relevant to the audit
Terms: Other communications with audit committee
Diff: Moderate
Objective: LO 24-7
AACSB: Reflective thinking
Topic: SOX
7) Auditors are required to communicate either orally or in writing with the audit committee
about internal control weaknesses.
Answer: FALSE
Terms: Auditors required to communicate with audit committee; Internal control weaknesses
Diff: Moderate
Objective: LO 24-7
AACSB: Reflective thinking
45
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8) The Sarbanes-Oxley Act includes additional communication requirements for auditors of
public companies.
Answer: TRUE
Terms: Sarbanes-Oxley and communication requirements
Diff: Moderate
Objective: LO 24-7
AACSB: Reflective thinking
1) The audit firm issues an audit report for its client. The auditors have no obligation to make
further inquiries with respect to the client's audited financial statements unless
A) a development occurs that may affect the company's long term viability as a company.
B) final resolution was made on disclosed contingency for which no liability needed to be
accrued.
C) new information comes to the auditor's attention concerning an event that occurred prior to
the date of the audit report that, if known, would have impacted the audit opinion.
D) a lawsuit, in which the risk of loss was considered remote, was resolved in the company's
favor.
Answer: C
Terms: Audit report; Further inquiries
Diff: Moderate
Objective: LO 24-8
AACSB: Analytic thinking
46
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2) The fieldwork for the December 31, 2016 audit of Treble Corporation ended on March 17,
2017. The financial statements and auditor's report were issued and mailed to stockholders on
March 29, 2017. In each of the material situations (1 through 5) below, indicate the appropriate
action (a, b, c, d, or e). The possible actions are as follows:
________ 1. On January 16, 2017 a lawsuit was filed against Treble for a patent infringement
action that allegedly took place in early 2014. In the opinion of Treble's attorneys, there is a
reasonable (but not probable) danger of a significant loss to Treble.
________ 2. On February 19, 2017, Treble settled a lawsuit out of court that had originated in
2015 and is currently listed as a contingent liability.
________ 3. On March 30, 2017, Treble settled a lawsuit out of court that had originated in 2014
and is currently listed as a contingent liability.
________ 4. On February 2, 2017, you discovered an uninsured lawsuit against Treble that had
originated on August 30, 2013. There is a reasonable (but not probable) danger of a significant
loss to Treble.
________ 5. On April 7, 2017, you discovered that a debtor of Treble went bankrupt on January
22, 2017, due to a major uninsured fire that occurred on January 2, 2017.
Answer:
1. b
2. a
3. e
4. b
5. d
Terms: Actions for subsequent events
Diff: Challenging
Objective: LO 24-8
AACSB: Analytic thinking
47
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3) If an auditor discovers that previously issued financial statements are misleading, the most
desirable approach to follow is to request that the client issue an immediate revision of the
financial statements containing an explanation of the reasons for the revision.
Answer: TRUE
Terms: Auditor discovers that previously issued financial statements are misleading
Diff: Easy
Objective: LO 24-8
AACSB: Reflective thinking
4) Subsequent discoveries of facts requiring the reissuance of financial statements arise from
events occurring after the date of the auditor's report.
Answer: FALSE
Terms: Events that occur after the date of the auditor's report
Diff: Moderate
Objective: LO 24-8
AACSB: Reflective thinking
48
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